Buying into private equity trusts should be considered as gaining ‘equity’ exposure rather than ‘alternatives’ exposure, according to Pantheon’s Andrew Lebus, who believes the sector as a whole is largely misunderstood by markets.
He says this is evident across the board within the IT Private Equity sector which, on average, is trading on a hefty discount of 14.1 per cent.
In fact, the Pantheon International trust itself is currently trading on a 15.85 per cent discount which, while in double digits, has been tightening recently compared to its one-year average discount of 22.23 per cent.
This could perhaps seem incongruous given its performance. Over one, three and five years, the trust has comfortably outperformed its FTSE Small Cap (ex IT) benchmark, its average peer and – as a point of reference – the MSCI AC World index.
Performance of trust vs sector, benchmark and index over 5yrs
Source: FE Analytics
Over 10 years, the trust has outperformed its sector average and benchmark by almost 40 percentage points with a total return of 101.96 per cent, but has underperformed the MSCI AC World by 28.12 percentage points.
This is due to a particularly torrid time during the financial crisis of 2008 when it finished the year down 71.41 per cent.
While this could be attributed to the lower level of liquidity within the asset class, Lebus says it is a case of needing a very long-term time horizon for investors to reap the benefits.
Since the turn of the millennium, for instance, Pantheon has returned an impressive 569.72 per cent compared to its benchmark and the MSCI AC World’s respective returns of 291.06 and 203.49 per cent.
“As equity investors, I always think the thing to do is ask what your savings needs are and how much liquidity you need to have. Investors who need liquidity and who have short-term time horizons shouldn’t be doing much in private equity,” Lebus said.
“But for those adding to long-term savings ISAs, SIPPs or who have pension-type savings horizons, they should be doing as much as they possibly can in private equity.
“If you look at the institutional investors who do this, such as defined benefit pension funds, they’re allocating between 5 and 20 per cent of their assets typically into private equity and that can be a significantly higher portion.
“What they’re doing is saying, ‘well how much liquidity to we really need?’ Why pay for liquidity? And that’s what you’re doing, you’re paying for liquidity.”
Investing in private equity has been daubed as complex or high-risk by some investors. However, Lebus says this area of the market is no less complicated than buying listed equities, which he says many investors buy into believing them to be more simple than they actually are.
“Equity is a complicated concept and private equity has features that add illiquidity and lock-ups; almost universally the fund structures we invest in are 10-year funds. That’s something a retail investor would never invest in and they’re generally not offered to retail investors,” he pointed out.
“It’s a market that has very little penetration other than through these types of listed funds by the retail investor.
“I think that means the media that is used to focusing on things that the retail investor is concerned with have had less experience of it and I think that, generally speaking, people tend to mistrust things that they understand less.
“I would say there are people who will argue that it’s simply leveraged equity and it attracts people who are simply looking to add risk to equity. We fundamentally disagree with that.”
Pantheon, which holds a combination of private equity funds and individual private companies, aims to minimise risk through diversification of region, sector and the stage at which companies are at in their lifecycle. For instance, 9 per cent of the trust is in special situations companies, 32 per cent is in growth companies and 16 per cent is in venture capital, or firms that finance early-stage businesses themselves.
Lebus says that, so long as the best management teams are selected, investors have no need to panic.
“The importance of picking the right managers is paramount because you will perform very well if you do and you won’t perform sufficiently better [than a listed equity fund] if you don’t. You’ll probably get a listed equity return if you don’t do a good job,” he continued.
“I think the quality of equity return in what we’re doing is higher than I could buy through other mutual funds, and it’s quite simply because the managers that are managing the equity know a whole lot more about the businesses they’re investing in and they have to, because they’re responsible for them.
“If it goes wrong, they have to deal with it. They know a heck of a lot more about what they’re investing in and they know a heck of a lot more about the real opportunities.”
For instance, the manager currently invests in a fund that only buys into US food businesses. He says this has a team of approximately 25 running it, and around one-third of those will be operating partners, who work directly with the individual companies in a bid to increase the value of the businesses.
He also argues that manager interests are better aligned within the private equity space, as managers tend to have a 10-year lock-up on all of their capital.
“We think private equity is more aligned between management of companies and investors than is the case in any other part of the equity market. This is because the management of those businesses are buying into and selling out of the equity at exactly the same time as we are as investors,” Lebus pointed out.
“The managers of the private equity funds also tend to have a vested interest on the basis of a realised cash return and, as soon as they realise the cash return, they send that cash back to investors.
“Everybody is picking up the benefit at the same time and that’s quite different from what is going on in other parts of the market. In the listed market you have options and other sorts of alternative schemes, but actually shareholders might have a completely different timetable to those managers.
“I think [private equity investing] is just not particularly well understood but I think that stretches across equities generally. It is complicated, people ought to be really careful and they ought to pay for advice.”
Pantheon International isn’t geared and has an ongoing charge of 1.26 per cent.