Interactive Investor

How we’ve returned 16% annually for 20 years

4th January 2023 16:36

by Sam Benstead from interactive investor

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Luke Finch, of private equity firm Hg, tells us how HgCapital Trust (LSE:HGT is managed – and why this approach has delivered 16% annualised returns over 20 years. Finch discusses the types of companies the trust buys, and more.

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Luke Finch of HgCapital Private Equity Group, which manages HgCapital Trust. Luke, thanks very much for coming in.

Luke Finch of HgCapital Private Equity Group, which manages HgCapital Trust: Morning. Thanks for having me.

Sam Benstead: So, please tell me about the trust. What is it and what is listed private equity?

Luke Finch: Sure. Well, the trust is Hg's largest investor. It's a listed investment company. It's a member of the FTSE 250, it's about nearly £2 billion of market cap, and it's been going for over 25 years. Hg Trust invests in funds managed by Hg, and what we do is buy B2B software companies, data businesses and tech-enabled services companies, and we buy those privately, as a private equity firm, and HGT gets to participate in all those investments.

Sam Benstead: And Hg is a big European private equity firm. What is its relationship with HGT, the listed trust?

Luke Finch: Hg is probably the biggest private equity firm in Europe that no one's ever heard of. We manage close to $55 billion (£45 billion) for nearly 300 institutional investors globally. We are the manager of HGT, so the independent board of HgCapital Trust appoints Hg as their manager on a rolling basis, and we manage their vehicles alongside the vehicles containing the other institutional investors.

Sam Benstead: And the trust is one of the best-performing investment trusts ever. It's returned about 17% over the past 20 years. How have you achieved those returns?

Luke Finch: Yes, I think the Association of Investment Companies (AIC) came up with some analysis earlier this year saying it is the best-performing investment company in the UK over the last 20 years, which is fantastic. We buy boring, mission-critical software companies that businesses need to help them operate, to help them be more efficient, and we buy a lot of those businesses. We have over 55, or I think 55, in the portfolio right now. And we've bought hundreds of them over the years. As the manager, as the investor, we hopefully get a little bit better every time we make an investment. We learn a bit more; we help those businesses grow faster and Hg Trust benefits from all that knowledge.

Sam Benstead: And why are these boring business to business companies so effective?

Luke Finch: Well, software ultimately helps businesses run more effectively and more efficiently. I mean, if you think about your own experiences, how many apps does interactive investor now load on to your phone to help you manage your expenses or reporting or compliance? These are jobs that used to be done by people with pen and paper or spreadsheets and software just remembers things better than humans can, it keeps records better than humans can. And wherever there's compliance-enforcing record keeping, software is part of the solution to help businesses perform. And so, that's the trend we're backing really. We're backing the trend of making expensive workers more effective and helping automate the more mundane elements of their jobs.

Sam Benstead: And are these types of companies quite recession-proof? Have you seen any changes in profits or revenue this year?

Luke Finch: No. Some of our biggest businesses have been reporting their best-ever months or quarters recently. If you think about tax software, your book-keeping software, your payroll, your enterprise resource planning (ERP), some of your compliance software, as long as you are in business as a customer, you need to pay your taxes, you need to pay your people, you need to comply with your regulations. And so, it's a bit of a non-discretionary purchase you have to do it. And then when times are getting tougher, you need more efficiency. So, if people, if your employees are getting more expensive, you need to automate more to survive. One of our biggest businesses is a company called Visma. It operates in Norway and the Nordics, and the Netherlands, increasingly. Norway is one of the most expensive countries in the world to operate. It's a very high labour-cost environment, and Visma's tagline for many years was ‘automate or die’. If you're not automating, if you're not helping your workforce become more efficient, then you're not going to win.

Sam Benstead: Can you speak about some of the other big positions in the portfolio? Access is another top holding, isn't it?

Luke Finch: Yes, so Access is now one of the UK's largest software companies, it's a real success story. We first invested in it three or four years ago, it was about £1 billion of enterprise value. It's now £9 billion and growing fast, the fastest it's ever grown. It's just put out public earnings. It's not public, but we encourage some of our big businesses to report outwardly, and its growing profits at about 40% over the last 12 months. It does ERP software across a series of event verticals, and it's a fantastically managed business with great processes. It's converted a lot of its systems to software as a service (SaaS), which provides more value to the customers. It relieves more pain points for the customers, and therefore the customers value that product more and more.

Sam Benstead: Can we just break down some of those acronyms please? ERP, SaaS, what are these business sectors and why do you like them so much?

Luke Finch: Well, SaaS is the delivery of software, so if you rewind the clock 10, 20 years most software was sold as a CD-ROM and you downloaded that on to your laptop or put it on to your server in the building, and it was sold as a sort of upfront cost, and then maybe you bought an update from Microsoft or whoever every year.

What SAS has done is it's changed it, it's delivered over the internet, over the cloud. It's continuously up to date and it doesn't reside on your servers or your laptop, it resides on Microsoft's cloud. That allows Microsoft, or whomever, access in this case to just do more. You know, it's always got new modules that it can upload. Everyone's always running the latest software. You can see how your customers are using the software and improve it better, and you can sort of track where they're using it, what it's delivering, where they need more help, and it just allows you to be a better service provider and to give your customers more innovation.

Sam Benstead: Why should investors own private stocks? There are many brilliant companies in the public markets. Why is that potentially a bit of a gap in the typical DIY investor’s portfolio?

Luke Finch: Well, look, I say if you're if you're sitting in the US, there are some very large, very brilliant software companies out there that you can go and buy, you know, Microsoft Corp (NASDAQ:MSFT), etc, Intuit Inc (NASDAQ:INTU). These are things that I own personally, but they're huge. They're hundreds of billions of market cap. If you're here looking for UK or European exposure to software, there's really not that much, and that's because most of it sits inside our portfolio or other private equity portfolios. So, if you add up the value, the enterprise value of our 55 companies, it's over $100 billion of EV, so we are behind SAP SE (XETRA:SAP), the largest kind of player in European software. Behind that, there's much smaller businesses like Sage Group (The) (LSE:SGE), which is, I don't know, sixth or seventh now, maybe more. And then other businesses are being taken private all the time, or getting bought by bigger software companies, so there's not a lot of sort of listed software companies in Europe for investors to hold. I like to think of HGT, Hg Trust, as almost the free float of that kind of 100 billion euro EV portfolio that we've assembled.

Sam Benstead: So, you buy the private businesses. How do you realise the gains from your investments? Do they go public? Do you sell them to another private equity investor? And what's the typical return from when you buy a company for the first time or when you realise that gain?

Luke Finch: So, over the years in our software deals we've had close to 70 exits and our gross returns on those have been over three times your money. What that translates down to at the trust level, as you said earlier, is a 17% compounded growth over very long periods.

The way the trust works is when we make an investment, we take cash off its balance sheet and put it in those companies. And when we sell an investment, the cash goes back, hopefully, you know, two to three times or more. And that snowball for the trust keeps on rolling. When I started working with the trust 13 years ago, it was about £200 million of market cap. Now it's close to £2 billion just from that ball rolling. When we're selling our companies, we're often selling them to other sponsors or to sort of larger software companies, sometimes in the US, who are consolidating markets or in particular want to come into the European market. The US firms entering Europe, buying businesses from us, is one of the best ways for them to do that.

Sam Benstead: Have you been very busy this year? What have been the biggest purchases and exits?

Luke Finch: Yes, we've been very busy this year. We've been sort of broadly in balance, in fact, in terms of sort of investment activity versus exit activity. So, for all our clients, including Hg Trust, we've sort of bought and sold about $6 billion worth of businesses in each side. Some of our bigger acquisitions this year have been a business up in the Nordics, up in Sweden called IFS, which again is a ERP software business focused on companies with lots of fixed assets, hard assets, and we think it's got the best, most modern product in the world for those customers, so we're delighted to be invested in that, and we also took private one of the UK's biggest software companies, a business called Ideagen, which was listed in London, and we took that private halfway through this year at just over £1 billion of enterprise value.

I mean, an interesting aside there, Ideagen, it's a business we've long followed and tracked, it's done very well for the public shareholders. But the management team there and the founders and the board felt that if they stayed public, they would become a consolidatee because someone bigger would come and buy them. In private hands, with our supportive capital, with a long-term mindset behind them, they could become a consolidator of their little segment. And that's why ultimately the board recommended selling to our funds.

Sam Benstead: Have you got a good pipeline of companies to invest in? What's your process for finding new investments?

Luke Finch: So, we have at Hg, over 150 investment professionals and 60 plus operators, and an overall team of about 350 people. Their sole job is to find great B2B software, data services businesses in very specific end markets. So, we've got nearly 20 people just looking at tax and accounting software mainly in Europe, so no one else has that kind of scale as focused as we have. And that means we build wish lists of companies, so there's about nearly 14,000 companies in our tracker. We're never going to own all of them.

We're trying to choose, you know, maybe eight to 10 of those a year to back. And we follow these companies a long time. So typically, we've known, and interacted with, and spoken to, and tracked, and discussed a specific company for five to 10 years before we invest.

So, that wish list of really well qualified, are sort of absolutely top of the wish list, there's typically 100 companies at any one time on that. And then we try and persuade them, often they're founder-owned, so it's explaining to the founder or the management team why becoming part of the Hg portfolio is valuable for them.

Sam Benstead: Luke, thank you very much for coming into the studio.

Luke Finch: Pleasure.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel. Don't forget to, like, comment, and subscribe. See you next time.

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