The portfolio invests in funds that focus on mid- to large-cap buyouts where there is “growth potential”, according to Mr Gunn. That results in the portfolio being more heavily exposed to sectors such as healthcare, technology, financials and consumer.
He continues: “We invest in private equity funds in two ways: we participate in the primary fund market, where we make a judgement on the manager and give them capital to invest over a five-year period. And we also acquire private equity fund interests via the secondary market, so we are buying assets that are mature portfolios.”
This fund of funds is a relatively concentrated portfolio of between 35 and 40 investments.
Mr Gunn says the investment process starts by whittling down a forward buy list of 350 managers. “It’s a six-month diligence process when we’re making an investment and we really focus on the team, how they find deals, what’s their value add, what’s their track record and how they manage debt in the underlying portfolios,” he explains, setting out the bottom-up part of the process.
The portfolio has a northern European bias and tends to be underweight southern Europe, so has little exposure to Spain and Italy. “We tend to be overweight countries such as the Nordics and Germany. We’ve been shifting some capital into the Benelux and Dutch markets as those economies have been doing better more recently,” he says.
Mr Gunn notes: “Our top-down approach is really looking at the macro, the political, the private equity landscape and asking, where should we be going to get the most attractive returns for shareholders? The key thing is we look for private equity fund managers who have an additional value add. We want to see them have an industrial expertise, or some kind of sector focus.”
Perhaps the biggest change in the trust over the past few years has been its shift to secondary assets, which has improved the maturity profile of the trust. These have surprised Mr Gunn by generally performing ahead of expectations.
The investment trust charges a management fee of 0.8 per cent of NAV, while the performance fee is calculated over a five-year period – the first period ends on September 30 2016 – and that represents 10 per cent of excess NAV generated over an 8 per cent “hard hurdle”.
The trust has outperformed the AIC Private Equity sector across one, three, five and 10 years, placing it in the top quartile in each of those periods, according to FE Analytics. Over five years to September 6 2016 the trust delivered an 82.4 per cent return to investors, against the sector average of 57.8 per cent. In the past year to September 6 the trust generated a 22.1 per cent return, compared to the peer group average return of 8.7 per cent.
The trust has a 15 per cent allocation to the financial services sector, with Mr Gunn remarking that “private equity never really participated in that market before the financial crisis but, since then, it’s become a much bigger bit of our portfolio”.
He admits: “Earlier this year, Candover realised a company called Stork which was valued at 0.6 times, but they realised that for 0.4 times – so coming in below the NAV for us. We are always disappointed where managers realise the companies for less than they say they’re worth.”
Since the referendum Mr Gunn has seen a slowdown in UK private equity deals but a spike in continental European deals. He points out: “There will be tougher times ahead as the UK’s new relationship with Europe becomes clearer. It will have a knock-on into the European market.”
But with large cash reserves of £110m in the trust at the moment, he insists there is “good tactical capital” to invest when the trust does find value opportunities.
