However, this overlooks a fast-growing part of the global investment landscape that has delivered historic outperformance: the $4.7tn (£3.4tn) in funds focused on private companies.
When unlisted companies announce their intention to IPO, the news is often greeted with excitement in the press amid speculation around the offer price and the potential returns for investors buying in at that point.
This type of investing often carries higher risk, however, and therefore requires specialised skills and experience to identify the potential successesLess commonly, details emerge of the gains accruing to the original backers: the venture capital funds able to invest at an early stage, often many years prior. Typically these funds pool money from professional investors and institutions.
The experienced fund managers then deploy investors’ capital into a range of start-up or early-stage businesses. Many of these young companies fail but some go on to become so-called 'unicorns' – billion-dollar-plus companies disrupting or dominating their industries.
Think Airbnb in the US or Trustpilot in the UK – both backed at an early stage by venture capital funds.
The examples above are well-known to a UK audience, but increasingly this type of opportunity is available further afield. China now has the largest number of unicorn companies globally thanks to a fast-growing and dynamic venture capital ecosystem.
This type of investing often carries higher risk, however, and therefore requires specialised skills and experience to identify the potential successes while trying to avoid the failures.
Market opportunities
Many public market investors may not realise they have the opportunity to gain exposure to professionally managed portfolios of private companies around the globe, well ahead of any IPO or exit, simply by purchasing shares in a London-listed private equity investment trust or company.
The first investment trust, Foreign and Colonial, was established in Britain more than 150 years ago in 1868 to pool money from “investors of moderate means” and purchase a portfolio of overseas government bonds.
According to the Association of Investment Companies, today there are 392 investment trusts that provide exposure to a whole range of assets, including conventional listed equities, infrastructure portfolios, commercial property and, of course, private equity.
The latter group fell out of favour during the global financial crisis of 2008-09 and has yet to fully recapture the attention from investors that it once enjoyed.
Trust discounts
Most trusts in the sector are trading today on wide discounts to net asset value while the more mainstream sectors are at par or even a premium.
The discounts are perhaps surprising when you realise that the listed private equity sector offers early stage exposure to the kinds of opportunities described above, and that the same private equity groups who manage these portfolios often raise billions of dollars a year from institutional clients away from the public markets.
For investors who may be interested in gaining exposure to private equity, one potential concern today is the prospect of a rotation out of growth-oriented technology stocks and into value, that is, unloved traditional businesses trading at low valuations.
Were this to happen, however, listed private equity trust portfolios would potentially benefit from another type of exposure that they typically provide: the more mature buyout investments whereby a manager takes a controlling stake in an established business.
Many of the investee companies are large enough to be listed on stock exchanges, but their owners have chosen to keep them private rather than file for IPO.
Instead, they seek capital injections from private equity managers who offer to partner with management teams and drive value creation over a period of several years, without obsessing unduly over short-term results, as is often the case in the public markets.
In private equity, the interests of owners and managers are aligned in pursuit of the best possible outcome for the business. Historic track records indicate strongly that this partnering approach delivers returns in excess of the public equity indices over extended time periods.
Good value
It might also be said that the listed private equity investment trusts in themselves represent value: they have generally performed well yet are available at wide discounts to their published NAVs.
At present, there may be additional latent value in their portfolios, as some of the NAVs are still based largely on valuations last updated at the end of September 2020.
This is because valuing private company investments takes time, often resulting in a lag of several months before the latest quarterly figures are included in the fund NAVs.
Private companies are often valued with reference to a comparable set of public companies. Given the strong performance that we saw from the public markets in Q4 2020, the December valuations have the potential to drive significant gains.
Some brokers are anticipating further NAV upside; increases that may not yet be priced into the listed private equity trusts’ shares.
Leave it to the professionals
Since the returns in private company investing can vary widely, it is better left to experienced professionals to try and identify the best opportunities, while also limiting downside risk and managing the complex processes and cash flows involved.
Furthermore, these managers are increasingly focused on environmental, social and governance considerations and, as private owners, are often able to take decisive action where necessary to enhance a company’s performance in these areas.
This may partly explain why private equity coped relatively well with the Covid crisis: managers know their portfolio companies intimately and can help them adapt quickly to changing circumstances, protecting and enhancing value for stakeholders long-term.
Some listed private equity trusts have delivered double-digit returns consistently for many years, yet their persistent discounts suggest the market is not giving full credit for this outperformance.
However, investors familiar with the sector have quietly been reaping the rewards, with share prices more than tripling in some cases over the past 10 years.
There are signs that more professional money managers are waking up to the opportunity, with share prices ticking higher in recent weeks in anticipation of the prospective results to come. Are we seeing the beginnings of a rerating?
Richard Hickman is director of investment and operations at HVPE
