This sector has fared well over the past year, but plenty of value remains for investors hunting for meaty discounts.
One corner of the investment trust universe that has fared pretty well over the past year is the listed private equity sector. Among the recent results for the calendar year of 2020, Schiehallion (LSE:MNTN) topped the tables with net asset value (NAV) total returns of 42%, while HgCapital (LSE:HGT) and BMO Private Equity (LSE:BPET) both chalked up NAV growth above 20%.
A recent note from Winterflood explains that there was a point last year, as the coronavirus pandemic gripped the country, when it seemed the sector might be as severely knocked back as it was by the global financial crisis of 2008 (when average share prices for listed private equity trusts fell 65%).
This did not play out. Levels of investment activity held up, particularly in the second half of 2020. High-profile areas such as healthcare and technology especially attracted investment, but as Winterflood reports, “even in general, it was clear that lockdowns did not hamper the industry’s ability to do deals last year”.
It was further helped through the second half of 2020 by recovery in public markets through the autumn, and also by a surge of interest in IPOs.
More broadly, the sector has prospered over the past five years.
Andrew McHattie of the McHattie Group, which publishes the Investment Trust Newsletter, makes the point that as public companies have declined in number, “many investors have been paying more attention to the growing market for unlisted companies”.
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By definition, it is not easy for private investors to find out much about such businesses, but private equity investment trusts, with their specialist managers and closed-ended structure, are an attractive way to access this hard-to-reach and illiquid part of the market.
Moreover, it is an area where there’s scope for dramatic uplifts when trusts sell successful holdings. “A lot of latent value can be bubbling under the surface - so not only can you frequently buy at a discount to the quoted NAV, but that NAV will itself often be conservatively calculated, with scope for positive surprises. Unearthing 'double discounts’ can lead to some accelerated returns,” McHattie explains.
Growth in interest has been supported by strong performance. All but two listed private equity funds have outperformed the FTSE All-Share over the last five years, according to Winterflood, with HgCapital leading the way on share price growth of 232%.
Yet discounts – although they have narrowed – remain meaty. The sector average at the end of March 2021 was -14%, compared with -36% at its nadir 12 months earlier.
That’s narrower than its 20-year average of -17%, but, says Winterflood: “We believe that it is entirely justified by the performance of the sector and still compares well with the wider investment companies sector, which is sitting on an average discount of between 2% and 3% at present.”
McHattie describes private equity as having been “the ‘deep value’ pocket of the investment trust sector”. He believes that although discounts have narrowed, there is still value to be found “if you are prepared to dig into the quirks of lesser-known trusts like Oakley Capital Investments (LSE:OCI)” (which gained around 150% over five years yet still sits on a -23% discount).
Looking ahead, Winterflood agrees there’s still value to unearth, and that discounts are likely to narrow further as the sector continues to thrive. There are several reasons for optimism.
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The investment focus has been more on higher-growth companies in areas such as technology; moreover, “an environment that provides cheap debt and favours growth should be supportive to the asset class”. Meanwhile, private equity trusts themselves look robust, with “strong balance sheets” and likely continuing investment levels.
The difficult years after the financial crisis weeded out weaker trusts, and those left “are in good shape and in most cases have something to commend them”, from the quality of the investment team to the dividend yield.
Winterflood picks out Standard Life Private Equity (LSE:SLPE) (-9.5% discount) and private equity fund-of-funds HarbourVest Global Private Equity (LSE:HVPE) (-20%). Discount figures are to close of trading on 27 April.
McHattie, too, highlights Harbourvest for diversified exposure. “The trust has a strong track record - the best in the fund of funds sector over three and five years - yet trades on a relatively wide discount,” he says. Stifel, another broker, also has a buy recommendation on it.
In addition, McHattie likes HgCapital Trust, “a truly outstanding performer for an extended period”. He suggests waiting to buy until the current 12% premium eases back.
“This is perhaps a handy reminder that while valuations are important – and more tempting in the private equity sector than in many others at present – it is management quality that ultimately determines the returns from what are complex markets based on privately negotiated deals,” he adds. “That’s why this trust might still be worth buying on a premium rating.”
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