This Is Money
With shares of many private equity trusts trading at a huge discount, is now the time to pounce?
Story by Anne Ashworth
The word ‘discount’ is one of the most enticing in the English language.
But in the case of private equity investment trusts, discounts are provoking more suspicion than excitement at present.
The share prices of many of these trusts – which back the unlisted businesses poised to become tomorrow’s stars – are at a yawning discount of as much as 40 per cent to their net asset value (NAV).
These trusts may provide useful exposure to burgeoning enterprises – in financial services, retail and technology in the UK, the US and Europe.
But such is the size of the discounts that many are concluding that private equity trusts are cheap for a reason, rather than one of the best buys of the autumn of 2024.
Opportunity: Charlotte Morris is co-manager of the Pantheon International Partners trust
Such is the level of distrust that some are even looking askance at the one trust in the sector which stands at a huge 56pc premium to its share price – and has provided a 1070 per cent return over the past decade.
This is 3i Group, a FTSE 100 company founded in the post-war period as Investors in Industry.
Today the £32billion trust is best known for its 58 per cent stake in Action, the convenience store chain with 2,725 outlets in 12 European countries.
But is the gap in our understanding of these trusts as large as some of the discounts? Ben Yearsley of Fairview Investing argues that there is a ‘disconnect’ between the reality and the market’s perception. ‘Over the long run these have been very good investments to own, although you need to buy for a decade or so,’ he says.
Charlotte Morris, co-manager of the Pantheon International Partners trust, highlights the breadth of the opportunities available.
‘We are putting money into growth-orientated companies operating in defensive, non-cyclical sectors, that are benefiting from long-term trends such as ageing demographics, automation, digitalisation, and sustainability,’ she said.
Pantheon’s portfolio includes such companies as Smile Doctors, a growing US orthodontic chain Altamont Capital Partners and a small chunk of Action shares. If you prefer to be brave when others are fearful, you may be intrigued by the chance for diversification that private equity trusts offer, especially following reforms to the cost disclosure rules which made their fees seem prohibitively high.
Moreover, the finance-hungry businesses favoured by private equity trusts should be boosted by further downward moves in interest rates. The high cost of borrowing has been one of the causes for the size of discounts.
But you should be prepared for a trip into unfamiliar territory.
Very few of these trusts’ investments have names that you will recognise, although the £1.7billion HarbourVest Global Private Equity (HPVE) has a small slice of Shein, the controversial Chinese fashion giant, reputedly poised for a £50billion London stock market flotation.
HPVE, the second-largest trust in the sector, is at a discount of 43 per cent, down from 52 per cent in March last year. But although most of the firms backed by private equity trusts may be obscure, they aren’t necessarily struggling.
James Carthew of analytics group QuotedData points to figures from MSCI Burgiss showing that the profits of management buyout businesses have grown faster than those of the average listed company in nine of the last ten years.
One reason for the expansion of the discounts is the belief that trusts are too optimistic about the valuations of their holdings, leading to disappointment when these stakes are either sold off or seek a stock market quote.
Analysts beg to differ.
Carthew says: ‘In general, valuations in the sector tend to be conservative.’
Iain Scouller of Stifel adds: ‘We expect sales of companies from these trusts’ portfolios to pick up over the next year.
‘Typically, when an investment is sold, it is at a gain of 20 per cent-30 per cent above its prior valuation – which results in an increase in the trust’s NAV.’
Nevertheless, the questions over valuations are likely to continue. The ShadowFall hedge fund, led by Matthew Earl, aka ‘the Dark Destroyer’, is shorting 3i’s shares on the basis that the trust is taking too rosy a view of Action. The £14.8billion stake makes up 72 per cent of the portfolio. Earl contends that 3i is valuing the chain at 18.5 times earnings, against the average of 14.4 times for this type of retailer.
The Dark Destroyer’s assessment is disputed, of course, with some extolling Action’s strength and prospects.
Carthew points out that ShadowFall’s claims ‘run contrary to all evidence of Action’s impressive growth record’.
But he wonders whether 3i should contemplate realising its stake in the chain to distribute some cash to shareholders and seek out other businesses that could be poised for greatness.
After all, 3i’s slice of Action is worth 120 times more than when the trust first saw the potential of the chain in 2011.
The row over Action will rumble on, although there will be significant interest in the prospective sale of 3i’s majority stake in pet food group MPM, maker of brands like Applaws for cats.
Meanwhile, analysts still predict a further increase in the trust’s shares from the current 3300p to 3500p. This compares with 1993p in November last year when 3i featured in this column.
At that time, I followed my own advice and put some cash into shares of this trust. I am staying on board because the argument over Action’s value seems set to have entertainment value.
Experts’ picks in the sector include Hg Capital, which is Europe’s largest investor in software companies. There is a 2.5 per cent discount on this trust which prefers companies where the executives have sunk some of their own cash into enterprise. The shares stand at 518p. The average analysts’ target is 540p.
Yearsley likes Pantheon, which is at a discount of 34 per cent. Its shares, stand at 318.5p, but analysts forecast a rise to an average of 395p.
He is also a fan of NB Private Equity which is at a discount of 25 per cent. This trust has a tiny slice of that popular retailer Action but mostly concentrates on the US. The average analysts’ target price for the shares – which are trading at present at 1532p – is 2374p.
Carthew cites Oakley Capital Investments as one of his favourites. The trust, whose discount is 30pc, focuses on digital consumer companies, education and technology, seizing some bargains in these sectors in recent years. The shares are up by 10p to 500p over the year so far. But analysts are targeting a rise to 656p.
Jason Hollands of BestInvest thinks that HarbourVest Global Private Equity has the potential to deliver some strong returns.
The current share price of the trust, which employs several teams of managers to locate the best deals, is 2335p but analysts have set a target of 3796p.
Some of this optimism is likely to arise from the conviction in some quarters that the discount is ludicrously large – and that the markets come to realise this and undergo change a heart.
The outlook for this and other private equity trusts is undoubtedly better than before, with more holdings likely to be disposed of at decent prices.
There is no timetable for the narrowing of the discounts. But, while you wait, you will be backing growing businesses, acting as a venture capitalist from the comfort of your armchair.
