Discounts in listed private equity funds belie performance

Elliott-Simon-Winterflood-2016-CUT

Listed private equity funds have performed strongly both in share price and NAV terms since the financial crisis eight years ago. Despite this, the subsector has continued to trade on a wider discount than seen elsewhere in the investment trust universe. We suspect this is a hangover from the financial crisis.

Prior to 2008, the long-term track record of the private equity subsector relative to the wider market was good, with strong outperformance, particularly in 2004 and 2005. However, in 2008 the subsector fell 65 per cent in share price terms compared with a 30 per cent decline for the FTSE All Share. Since then it has recovered significantly, up over three times since the end of March 2009, substantially ahead of the UK market. By calendar year, the private equity subsector has outperformed in each year since 2008.

A key driver of its performance in recent years has been discount moves. The sector average discount widened from midway through 2007 reaching more than 60 per cent at its nadir in September 2008. Discounts narrowed to an extent in 2009, following refinancing and strategic sales, but thereafter traded in a range between 20 per cent and 40 per cent reflecting low risk appetite and concerns over prospects for the sector. From the third quarter of 2011 discounts narrowed as markets rose and private equity funds benefited from a strong period for realisations, which has continued to this year. In addition a number have looked to return capital to shareholders through tenders, buybacks or dividends, while others have adopted managed wind-down strategies. This includes funds such as Candover Investments*, Dunedin Enterprise and Mithras*.

10yeardiscount

After trading in a band between 10 per cent and 20 per cent in recent years, the private equity sector average discount widened in the first quarter of this year, although it has subsequently partially recovered. Increased volatility across equity markets and concerns overs the prospects for global economic growth acted as a headwind in the first few months of the year. However, despite fears over the impact of Brexit on the sector, many funds have benefited from a boost to their valuations from sterling’s recent weakness.

Over the past month a number of private equity funds reported interim results for the first six months of the year. Aside from currency, most reported progress in terms of underlying performance although valuation multiples suffered from the volatility in quoted markets in the first half of the year. Investment activity and the level of realisations have also remained strong and, in our opinion, financing risk is low given the conservative levels of outstanding commitments at present, particularly when compared with the position in 2007/8.

As the chart illustrates, the average discount on listed private equity funds has averaged around 20 per cent over the past five years and this has resulted in a wave of corporate activity. This has included, most recently, an unsolicited bid for SVG Capital from HarbourVest. In our opinion this underlines the value available across the subsector, although we believe that there is a considerable difference in quality across the different funds.

Private equity is a cyclical asset class with returns ultimately reliant on the conditions for profitable exits. We believe that private equity remains an attractive, long-term asset class. Its model incentivises management teams to generate long-term performance away from the glare of public markets. In our opinion the value that is currently on offer among listed private equity funds should be attractive to investors who can endure a higher degree of risk and take a long-term view.

Simon Elliott
Head of research at Winterflood Securities

*Denotes a corporate client of Winterflood Securities