Private equity trusts are one of the best sources of growth for investors in the current market, according to Hawksmoor’s Richard Scott (pictured), who says they are also very attractive from a valuation perspective.
Scott – who heads up the PFS Hawksmoor Distribution and Vanbrugh funds, recently told FE Trustnet that investors have to work harder than ever to find superior returns in the current environment. He pointed out that, in order to outperform, investors now have to take a higher degree of risk or a dip into less-liquid areas of the market and one area he says fits the bill is private equity.
Private equity is often left alone by retail investors given the perception that it is a higher risk asset class.
However, given that it is one of the few areas of the market which offers strong growth and is still trading on a relatively low valuation compared to more traditional listed equity markets and fixed income which are now more than six years into a bull market, Scott says now is an ideal time to look at the sector.
Performance of sector versus indices over 8yrs
Source: FE Analytics
“Private equity is an area, as investment trust enthusiasts, we recognise as a wonderful source of potential value,” he said.
“We also think we are in the type of economy where you have to work hard to generate growth as there isn’t a strong economic tailwind. You need investors who are really engaging with different companies and different areas of the economy to achieve growth greater than the average.”
He added: “Private equity is ideally suited to do that.”
Private equity is an asset class that comprises of equities and debt in companies that are not on the stock exchange or publically traded.
These companies are either privately-run or are public companies that have become delisted from stock exchanges as a result of ‘go private’ deals.
However, the ultimate goal of these private equities is for the company either to join the public stock exchange or to be listed once more, which is why as investment vehicles, they potentially offer a vast amount of growth.
Among other private equity trusts, Scott holds F&C Private Equity, HgCapital and Graphite Enterprise Trust. All of these are trading at double-digit discounts, with F&C Private Equity the trust with the largest discount out of the above, at 18.66 per cent. What’s more, this £221.5m trust’s discount is wider than its one-year average discount by 0.11 percentage points.
HgCapital is also trading at a significant discount of 11.1 per cent, which is wider than its three-year average by 0.45 percentage points.
While Graphite Enterprise Trust’s discount is relatively tight compared to its recent history, it is still trading at a discount of 14.85 per cent.
It’s important to note that the increase in risk appetite among investors over recent years, the increasing trend of company boards buying back shares and the implementation of the Retail Distribution Review (RDR) have all meant discounts have narrowed substantially across the closed-ended sectors over recent years.
Despite this, many private equity trusts, such as the ones that Scott holds in his portfolio, are still trading at what appears to be attractive values.
“They give you exposure to some really strong growth areas and areas that we believe are standing at comparatively low valuations. The valuations of private equity within the portfolios of these trusts are trading on discounts to quoted market comparators,” he said.
“That’s one reason why when these trusts manage to sell and release investments they usually do so with significant uplifts to the carrying values within their portfolios. But, despite that, with most of these trusts we are investing at significant discounts to even those conservatively stated net asset values.”
There are two ways in which to invest in private equity – through trusts such as F&C Private Equity and Hg Capital which hold direct shares in unlisted companies, or through ‘funds of funds’ which will hold specialist private equity funds as part of their portfolio.
Graphite Enterprise Trust holds a combination of direct assets and specialist funds, primarily investing in buy-outs of mature companies that are established in European private equity markets.
This balanced approach seems to have paid off, as the trust has outperformed its sector and benchmark by 22.53 and 32.05 percentage points respectively over five years.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
Graphite Enterprise Trust is not geared and yields 1.7 per cent.
Adopting an even more varied approach, Caledonia Investments trust, which Scott also has in his portfolio, holds a combination of private equity, listed companies and other investment vehicles which collectively have been divided into different “pools”
In an article last month, the team at Numis Securities explained that Caledonia – as a result of its new manager William Wyatt and its current double digit discount – offers significant value for long-term investors.
“Caledonia is still trading on a discount of c.16 per cent (versus a peer group average of 5 per cent). In part, we believe this reflects the fund’s substantial exposure to unquoted assets and the portfolio cannot be expected to perform in-line with markets,” Numis said.
“However, we believe that Caledonia offers significant value for long-term investors on its current discount.”
In terms of current positioning, Caledonia holds 28 per cent in quoted stocks such as AG Barr and Close Brothers, 31 per cent in unquoted companies such as Park Holidays and Bowers & Wilkins, and 20 per cent in open- and closed-ended funds, most of which are specialised investment trusts.
While this includes the likes of Chinese private equity fund Capital Today and North American-focused Perlus Microcap, Caledonia also has a smaller weighting in the Newton Asia Income fund.
The remaining 21 per cent of the portfolio, however, consists mostly of blue chip stocks, which the team deem as having strong balance sheets and high returns, and the money market, which has an 8 per cent weighting.
Scott said: “Caledonia achieved growth of almost 20 per cent over the past year from the 40 per cent of the portfolio (on a see through basis) that is invested in private equity.”
“That’s a fund where you can get a yield of in excess of 2 per cent as well and one which has grown its dividend in each of the last 48 years. It also charges all of its expenses against its income account, so it’s a true yield of above 2 per cent.”
“That’s the sort of opportunity you can get from choosing carefully within the investment trust sector that you which can’t find in open-ended funds.”
Over the last five years, Caledonia has achieved a total return of 76.05 per cent, outperforming both its benchmark and sector average.
Performance of investment company vs sector and benchmark over 5yrs
Source: FE Analytics
Trading at a discount of 16.1 per cent, the investment company is not geared. Its ongoing charges are 1.03 per cent.