Volatility set to linger

The FTSE 100 closed at the end of April at 6069 and closed on the 6th September at 5157.The US debt and political jousting and the loss of its triple A rating, alongside on-going concern over the Eurozone debt, coupled with nagging doubts over the prospect of a double dip recession, have taken their toll on markets.

Interestingly, investment company discounts have held up through this period. For example, the average Global Growth investment company is currently on a 10 per cent discount in comparison to 9 per cent at the end of April. The UK Growth & Income sector has even moved onto a premium of 1.5 per cent from a 3 per cent discount at the end of April underlining the current high demand for income.

However, discounts have widened once again across the private equity sector and although they are not at the extreme levels of 2008/9 they are historically wide at 34 per cent. Does this present a buying opportunity?

There are two types of private equity investment companies – those that invest directly in unlisted companies, and those that invest in unlisted companies indirectly through funds (funds of funds). Some private equity investment companies invest in both direct investments and funds offering a hybrid of the two approaches.

With the current worries over a double dip recession in mind, private equity portfolios would be affected by an economic downturn. However, gearing levels in the sector are currently lower and valuations are conservative but investment activity may slow down for the rest of 2011 if the economy slows down.

Doubts may remain after 2008 when theaverage private equity company’s share price fell 58 per cent in comparison to 37 per cent for the average investment company reflecting concerns over the viability of private equity investment companies considering the high level of outstanding commitments.

However, private equity investment companies have bounced back and since 2009 the Datastream Investment Trusts Private Equity index ex 3i is up 108 per cent in comparison with 37 per cent for the FTSE All Share and in 2011, the index is up 6 per cent compared with a market fall of 8 per cent, according to Winterfloods.

So why would you consider investing in a private equity investment company? Privately owned companies are assets which are difficult to invest in directly due to the high level of capital and experience required.

An investment company allows investors to gain exposure to this asset cIass, which provides the potential for returns in excess of the markets, via a professionally run portfolio of private shareholdings.

Of course, due to the relatively illiquid nature of unquoted companies private equity investment companies should be viewed as a long-term investment which can suffer severely during market downturns.

Simon Elliott, head of research at Winterfloods comments: “Private equity is a higher risk, higher potential return asset class. For investors who can take a longer term view and endure share price volatility, we believe that current valuations offer an opportunity.”