Ian Cowie: big discounts for private equity trusts, but I don’t own any

Our columnist says the government’s move to encourage company pensions to have some exposure to unlisted shares is good news for private equity investment trusts. However, while there’s big discounts on offer, he explains why he doesn't have exposure to this area.

Could a bad idea for the many be good news for a few? Might more risk for company retirement funds mean better returns from investment trusts in a sector where discounts to net asset values (NAVs) have doubled in the last couple of years?

These are among questions raised by Chancellor Jeremy Hunt’s Mansion House speech on Monday, when he said company pensions should invest 5% of their assets in “unlisted equities” - or shares that are not traded on any fully authorised stock exchange. He added that he already has the backing of Britain’s biggest fund managers for his exciting new strategy.

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Never mind, for a moment, what this might mean for millions of pension scheme members, who may - not unreasonably - be hoping these funds will pay for their old age. If Hunt’s brainwave becomes a fact, the Treasury says it would increase investment in unlisted shares - also known as ‘private equity’ - by between £50 billion and £75 billion.

That would be good news for more than a dozen investment trusts in the private equity sector, where most are currently priced more than 10% below their NAV. These investment trusts look cheap because Mr Market has lost his taste for ‘jam tomorrow’ stories since interest rates began to rise and is shunning shares whose prices had been inflated by hopes of growth in future.

Shavar Halberstadt, analyst at Winterflood Research, told me: “Coupled with geopolitical turmoil, this has repressed sentiment in general, and heightened scepticism towards private valuations in particular.

“As a result, the investment trust private equity sector has de-rated significantly, trading at an average discount to NAV of 33% as at the end of last month, from 15% at the start of 2022.

“Therefore, we believe that the depth of the sector de-rating is overdone. Any influx of capital resulting from regulatory measures will be welcome, particularly from sources with a long-term investment horizon. Sustained narrowing of sector discounts would generate a notable shareholder return.”

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Alan Brierley, an investment trust analyst at the stockbroker Investec is also positive about private equity. He said: “Investment companies in this sector with a 10-year performance record have impressive NAV average total returns compared to MSCI World and FTSE All-Share indices.”

Both Halberstadt and Brierley named HgCapital Trust (LSE:HGT) as a favoured option. It has total assets of £2.1 billion and delivered total returns of 306% over the last decade, 106% over the last five years and 9.7% over the last 12 months. HGT currently trades on a 23% discount to its NAV.

Meanwhile, Iain Scouller at the stockbroker Stifel, favours NB Private Equity Partners (LSE:NBPE), a £1.1 billion fund that delivered total returns over the same three periods of 290%, 82% and 8.9%, but remains priced 32% below its NAV.

Scouller explained: “NBPE has built a portfolio which is well diversified by industry, company and vintage.

“However, the market continues to worry about the risk of writedowns in the private equity sector as a result of falls in listed market comparable companies, a possible recession and higher debt costs.

“We think NBPE is relatively well positioned for this environment for several reasons, including low leverage, modest outstanding commitments and company-specific risk, with the largest 10 investments representing 35% of NAV. Also, the capital structure is being simplified with zero dividend preference shares due to be repaid in October 2024.”

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Unlike HGT, where the dividend yield is a modest 1.95%, albeit rising by an impressive 8.8% annual average over the last five years, NBPE is yielding dividend income of 4.8% without any annualised five-year increase.

Bargain-hunting income seekers might prefer Apax Global Alpha (LSE:APAX), the £1.1 billion fund that is yielding 6.4% income rising by 7% annualised over the last five years; or CT Private Equity Trust (LSE:CTPE), yielding 5.5% rising by 12.9% per annum. APAX and CTPE shares are currently priced 20% and 33% below their NAV figures.

Against all that, a fundamental problem with this sector remains that there isn’t much point looking for familiar names among these investment trusts’ underlying assets; by definition, you won’t have heard of most of them. So investing is an act of faith in the managers.

Another problem with the unlisted nature of these investment trusts’ assets is that it is impossible to be sure what they will fetch when they are sold. Therefore, apparently attractive discounts and NAV numbers might prove misleading.

So, like the great writer and terrible investor Mark Twain, prospective buyers of private equity funds could discover that distance lends enchantment to the view.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.