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Are private equity trusts a bargain?

Are private equity trusts a bargain?

The period from the end of the financial crisis to the start of 2022 created many market conditions that were ideal for private equity investment trusts.

Asset prices generally rose, while interest rates remained low, enabling such funds to boost returns, while many investors looked to such products as a way to achieve diversification away from listed equity and bond markets, which were rising stoutly.

This enabled trusts to borrow very cheaply, and deploy the capital into already rising markets, all the while charging active management fees. 

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But as this year has worn on, many of those trends have reversed, the cost of debt is higher, and many investors are prioritising liquidity at a time of market downturn, which means the outlook for the asset class has changed.

And that is reflected in the chart below, which shows the average discount to net assets at which private equity investment trusts trade has roughly doubled in the past year. 

In more normal circumstances, the price of an investment effectively halving in a year may prompt investors to buy more. 

But an issue unique to private equity trusts is they invest in companies not listed on any stock market, so the price of the investments they make is not calculated on a daily basis, as it is with investments made by other funds in listed bonds or equities. 

Anthony Leatham, investment analyst at Peel Hunt, says: “This sector sees a 3-4 month reporting lag from the underlying managers and at volatile times like these that can cause uncertainty around the 'true' value of the portfolio, which can impact sentiment and cause discounts to net asset value (NAV) to widen.” 

On your marks

Alan Brierley, director of investment trust research at Investec, says this can mean the valuations of the investments listed on a trust’s factsheet considerably lags the reality of what price those assets could actually be sold for if they were on the market today. These prices are known in the industry as 'marks'.

The discount or premium at which an investment trust trades is the difference between the total value of the shares in an investment trust and the total net value of the investments made by the manager of the trust on behalf of the shareholders. 

A trust trading at a discount to its net assets implies that investors do not believe the present value of the investments will be maintained in future, either as a result of lack of confidence in the fund manager, or in the asset class. 

Brierley says: “The key to understanding where private equity trusts are right now is that several of them have not written down the value of their investments to reflect where the market is now. Many of them do that only on a quarterly basis, and some even less frequently. The end of the year is the next point where many will revalue.”