First, let us recap on what the AIC has to report about its private equity sector. The trade body notes that with the results season in full swing for the Private Equity investment company sector, the challenges of the last year have become increasingly apparent. The sector has been hit hard by the credit crunch and the average sector discount currently stands at 43 per cent compared to 16 per cent a year ago.
Although the sector as a whole has been marked down, there are some positive signs, with some investment companies still in a position to take advantage of opportunities ahead. Trust managers believe that private equity can play a role in the economic recovery by stepping in where the banks are unable to provide finance, and taking on otherwise illiquid assets. Certainly the parameters have changed, but private equity can adapt to the need to refinance, restructure or provide the necessary facilities to make acquisitions; in other words, to do the deals that banks will not do.
Forced selling could bring great opportunities for those with capital to invest, providing much needed liquidity in exchange for assets with the potential for substantial value appreciation. Once company valuations come down there are outstanding investments to be made at the bottom of the cycle. The prevailing view is that this is the best environment for new deals for 20 years or more.
Relative asset performance, 1-yr
Source: Financial Express Analytics
Top 5 funds in sector, 1-yr
Source: Financial Express Analytics
One of the key strengths of the private equity model is its ability to bring capital and expertise to the table. Quality of management and alignment of interests have always been a sine qua non of this approach, and the model's expertise lies in recruiting and rewarding the best management talent available. As one of the few industries still with the resources to take advantage of new opportunities, sector members are well placed to make handsome longer-term returns on the recovery from a downturn.
From the investor's point of view, the listed private equity investment company structure offers advantages: due to their stock exchange listing, private equity investment trusts offer investors access to an established, transparent portfolio for the cost of a share. And because of the listed structure, these investment companies can be long-term holders and do not have to worry about having to sell good quality stock to meet redemptions.
This is not to say that investors can afford to adopt an indiscriminate buy-hold-forget policy. Now that we have come to it, the point is illustrated by two starkly contrasting examples from the Financial Express database. These involve trusts that emphasise capital growth in their investment objectives; they also distribute dividends to their shareholders, and their shares are trading at a knock-down discount to their net asset values. They are Candover Investments and Pantheon International Participations.
What they share in common is the eradication of the value of unfortunately-timed shareholders' stakes. Pantheon's total return over the year to 26 March hit a negative 77 per cent. Not to be outdone, Candover drained the pond with a 93 per cent torrent of investors' return through the sluice gates. But here's the difference.
Two of the most heavily discounted shares in the sector, Pantheon offers 1,126p worth of assets for 195p, while, similarly, a 1,026p chunk of Candover will cost a mere 116p. These are discounts in the 80-90 per cent region, and there is little beyond negative sentiment about private equity as a concept to explain them. Where it gets interesting is how these numbers translate for investors.
Shareholders in Pantheon will have seen little or no compensation for the decline in their total return. The running yield from the trust's performance statistics is zero, so there has been no net income either. By contrast, Candover's trust posts a 53 per cent yield, and we are talking here about cumulative dividends in 2008 of 62 pence on a £1-and-change share.
In conclusion, the private equity model still has long legs, the field is rich with opportunity and there are rewards to be had for the attentive investor with a broad investment outlook.
A note about investment trust discounts: Trustnet’s IT discount information is updated every day. Use this link to access it.