Explore investment trusts as a means to gain from the private equity sector's returns.
The Association of Investment Companies (AIC) reports that private equity trusts have topped the league in terms of share-price returns over one-, five- and ten-year periods, surpassing all other sectors. Over five years, it delivered returns nearly twice as high as the second-best performer, North America, and more than double over ten years, standing at 534%.
However, these trusts trade at some of the most significant discounts to net asset value (NAV) in the market, with an average of 21% for directly investing trusts and 37% for funds of funds (as of 3 April). It's worth noting that these numbers are influenced by 3i, a giant player in the sector, which trades at a 49% premium, with 73% of its asset value tied to a single investment – European discount retailer Action. 3i, recognized as the best-performing private equity trust, has multiplied investors' money almost tenfold over the past decade.
Among other top performers, six trusts, including Hg Capital and Oakley Capital, appear on the AIC's list of the 25 best-performing investment companies over ten years, underscoring that 3i is not an outlier.
Despite this, investors continue to show reluctance, particularly towards funds of funds, resulting in persistent discounts. One rationale to explain widening discounts in 2022 was that valuations had supposedly become unrealistic due to rising interest rates and falling equity markets.
However, with continued sales and strong underlying performance, the skepticism appears unjustified as time has passed. While asset value growth has slowed (averaging 5% over one year, compounded at 14% over five), this is primarily due to increased interest rates, which have since started declining.
Higher discounts for funds of funds were previously justified by low visibility of underlying investments, small individual impacts on performance, double-charging (due to the multi-layer structure), and uncertainty due to unfulfilled commitments to new funds.
However, industry brokers Stifel highlight that there has been a significant shift in the composition of these funds in recent years, with a rise in co-investments, direct company investments, that aim to circumvent the double layer of fees, increase visibility, and eliminate the headache of managing long-term unfunded commitments.
Co-investments offer several benefits, as they allow for lower fees, improved visibility, and the removal of the burden of managing long-term unfunded commitments. As a drawback, they require more time commitment due to their minority investor status and minimal influence over the investment decisions.
In response to high discounts, private-equity trusts have accelerated share buybacks, materially bolstering NAV. For instance, Pantheon purchased £200 million worth of shares in the year to 30 May 2024 but only £12 million in the next six months, primarily due to buybacks pushing the portfolio from net cash to net debt and outstanding commitments making up 31% of NAV. Yet, with shares trading at a discount of over 40% to NAV and distribution gains from exits increasing, more buybacks can be expected when capital becomes available.
Despite a 3% investment return over the past year, Pantheon's annualized return over ten years stands at 13%, with the average uplift on exited investments in the last financial year reaching 20% (against a long-term average of 30%). Furthermore, the performance of the underlying companies continues to remain robust, with average revenue growth of 11% in the past year and 16% growth in cash generation.
HarbourVest Global Private Equity, trading at a near-40% discount to NAV, has doubled its allocation to buybacks from 15% to 30% of gross distributions received, enabling potential buybacks worth £180 million this year, reducing the number of shares by 9% and reducing assets by just 6%. Despite a 20% allocation to venture capital, which has hampered recent performance, the long-term record of a 15.3% annualized investment return over ten years is remarkable, along with a 17% growth in cash generation.
ICG Enterprise Trust's sale of exposure to eight mature fund investments at a 5.5% discount to NAV may seem disappointing, but the £62 million gained enables buybacks of shares on a 37% discount to NAV and new commitments. The trust invests globally but only in buyout funds, with a diversified portfolio consisting of 1,151 underlying fund managers and 14,385 underlying portfolio companies, resulting in a highly diversified portfolio.
Despite being the second-best performer on the AIC's list with returns of nearly 500% over ten years, Oakley Capital Trust trades at a 32% discount to NAV. Although its annualized five-year return stands at 16%, the past two financial years saw returns of only 2% and 4%, primarily due to increased interest rates suppressing valuations. Despite an 8% cash holding and almost 20% investment in 2024, the trust has canceled its modest dividend to allocate £20 million annually for share buybacks and announced a £420 million commitment to a new fund, expected to be drawn over five years.
Owing to persistent negative sentiment towards private equity, characterized by associations with cost-cutting and financial engineering, wealth managers allocate only token exposure to these funds in their portfolios, and private investors fail to appreciate that private-equity trusts provide accessible avenues for the high returns offered through a tradable vehicle. As a consequence, a lack of demand leads to high discounts. However, in favorable market conditions, strong performance should cause these discounts to narrow or disappear, as evidenced by the transformation in 3i's market price.
- Investors' reluctance towards private-equity funds, particularly funds of funds, has led to persistent discounts in personal finance, with investors showing a preference for sectors other than investing in private equity.
- The Association of Investment Companies (AIC) has reported that private equity trusts have significantly outperformed all other sectors in terms of share-price returns over one-, five- and ten-year periods, with some trusts offering returns multiple times higher than the second-best performer.
- As a response to high discounts, private-equity trusts have adopted strategies such as co-investments and accelerated share buybacks to boost net asset value (NAV) and reduce discounts, with the aim of making private equity a more attractive investment option for individual investors and wealth managers alike.
