William Heathcoat Amory
For 2023, I doubled down on Hipgnosis Songs (SONG), having also chosen the shares for 2022. My original rationale was correct—that after 2021 which was a barnstorming year for equity markets, it might make sense to rotate out of equity beta, into an uncorrelated asset class. 2022 and 2023 subsequently turned out as hard for alternative strategies as it has for equities. Unfortunately, during 2023 SONG has faced a litany of troubles, and the shares remain on a wide discount. At current discount levels (to the published NAV) of over 50% at the time of writing just before Christmas, the shares must offer value. A new board has been appointed, now including noted deal-maker Christopher Mills of Harwood Capital. As such, patient investors may yet see a recovery in value, and with bond yields in the US now coming down we may see interest in song royalties start to recover: many private equity buyers are leveraged players and so valuations do correlate with bond yields.
For 2024 I am switching asset class, but remaining in private markets, where I continue to think there is significant potential for skilled investors to add considerable alpha. My pick is NB Private Equity Partners (NBPE), which is a private equity trust which focusses solely on co-investment. This is a process where private equity managers invite third-party investors such as Neuberger Berman (NB) into selected deals. NBPE is an equity investor, and sits alongside these third-party managers, typically on a fee-free basis. NB have long experience in co-investing and selects only those investments which it think have a strong likelihood of success. The historic track record is strong, but returns have been relatively muted since the end of 2021 as a result of two headwinds which in our view are starting to roll off. Firstly, during 2021 several of NBPE’s successful investments chose to IPO as a means of starting the exit process. NBPE remained invested in a rump of these quoted investments, which were negatively affected by the downturn in equity markets during 2022. At the same time, rising interest rates led to a significant slowdown in realisation activity, from the boom years of 2020 and 2021.
NBPE is in a strong position to weather a deal slowdown, because of the deal-by-deal way in which it deploys capital. As such, the trust is very unlikely to find itself overextended because of commitments, and it can deploy capital opportunistically. The portfolio is increasingly mature, meaning that many of the investments may be at a stage where the sponsor (or private equity manager leading the deal) is looking to crystallise value gains through a transaction. The portfolio of mainly US-headquartered companies has delivered strong earnings growth over past years, a function I believe of the strong stock picking delivered by NB. There is no guarantee of course that this will continue, but I believe that private equity-backed companies are more resilient than those on quoted markets. Fundamentally, the private equity industry has developed such that the resources that managers can lean on to support investee companies’ management is huge. They can react quickly to changed circumstances, and gain market share when dynamics change. Certainly, private equity-backed companies do tend to be more enthusiastic users of borrowing. However, we believe that there is evidence that whilst higher rates are a headwind, they are not an insurmountable or life-threatening challenge, especially as interest rates look to be on a downward trend.
NBPE’s discount has narrowed from its widest levels but still sits at a discount to NAV of c. 25%. Of more interest, in our view, is the latent potential of its investments. If deal activity starts to normalise thanks to interest rates starting to fall from their peak, then we believe there is potential for some strong progress on the NAV front. We think it is likely that dividends will remain the primary route for returning capital to shareholders. Over the last ten years, NBPE has returned c. $375m of capital, of which the majority has been through dividends that add to $316m over the period. NBPE’s board has not ruled out share buybacks, and so if the share price doesn’t keep up with the NAV, it clearly has to be an interesting and accretive avenue for re-deploying capital from realisations. A potential tailwind to the investment case, given that the portfolio is denominated in US dollars (USD), is recent USD weakness, which has fallen from 1.21 to the pound at the start of October, to 1.27 at the time of writing. Certainly, there are those (including FT journalists) who believe that private equity valuations are opaque and too high, and riding for a fall in the new era of higher interest rates. I’m not of the same view, believing that private equity managers, such as those that NB partners with for NBPE, create value in a repeatable process over cycles. NBPE is a great way to access this talent, hence why I am picking it as my trust for 2024.
William Heathcoat Amory
