OpinionJun 1 2023

'More investor education needed on the benefits of listed private equity'

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'More investor education needed on the benefits of listed private equity'
(Johnstocker/Envato Elements)
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Listed private equity has become an attractive option for investors seeking exposure to private markets in recent years.

Benefiting from liquid access to the traditional outperformance and resilience of private equity through investment trusts has proved a strong portfolio play for many investors across the retail/institutional spectrum. 

However, a persistent issue has impacted the sector: the discount to net asset value (NAV) that all private equity investment trusts currently face.

This discount fundamentally reflects the discrepancy between a trust's market price and its underlying NAV.

Many private equity investment trusts are currently trading towards the furthest ends of their historical discount ranges, with an abnormally large number of quality funds trading at discounts as wide as 40 per cent. 

Firstly, and perhaps most importantly, the discount is a sector-wide issue. Numis data shows that the current average discount stands at 35.5 per cent.

The discount is not a recent phenomenon, though it is impacted by macroeconomic events and has worsened following market turbulence in the past two years – the 10-year sector discount is 19.5 per cent. 

Discount to NAV across private equity sector

 

LPE sector average

Private Equity Direct

Private Equity VC

Private Equity Fund of Funds

ICs universe

Current

-35.5

-25.8

-40.5

-42.1

-14.6

LTM average

-35.1

-27.0

-34.4

-42.7

-12.3

10Y average

-19.5

-19.3

-11.5

-24.6

-6.3

Source: Numis

Numis data also shows that the average investment trust in 2022 was trading at just a 13 per cent discount to NAV – so why is the private equity sector so disproportionately impacted?

We saw the widening of private equity discounts coincide with the outbreak of the Russia/Ukraine war, and despite market recovery elsewhere since, the discount has remained. So, why are we not seeing the gap close? 

There are various historical misconceptions about private equity that we believe play into the discount and the investor sentiment behind it.

A perceived lack of transparency, particularly regarding uncertainty around how portfolios are valued, is a factor.

This leads to suspicions that private equity valuations are over-inflated, especially when considering how public markets valuations have dropped in comparison during recent turbulence. 

The sector’s discount is anomalous for various reasons. First, the private equity industry has a long track record of strong performance through market cycles.

Data from the global financial crisis shows that some of the best vintages come from periods of market dislocation and in today’s turbulent environment it has remained one of the best-performing, most resilient asset classes.

Private equity has the benefit of providing accessing opportunities that are simply not available to investors via the public markets.

In recent analysis of 14 private equity trusts, Investec found that over the past 10 years the trusts returned 301 per cent in NAV total return, compared to MSCI World and FTSE All Share total returns of 187 per cent and 76 per cent, respectively.

This is partially because private equity offers some shelter against volatility, given its long-term investment horizons and the active management it offers, providing portfolio companies with operational support to navigate changing market conditions.

With so many of the best companies staying private for longer, private equity also has the benefit of providing accessing opportunities that are simply not available to investors via the public markets.

It is also worth noting that listed private equity valuations are traditionally conservative. This is demonstrated by the fact that listed private equity firms typically exit investments at a significant uplift to carrying value.

Looking at a pool of five leading private equity investment trusts, Numis data shows that exits in 2022 were completed at an average uplift of 33.9 per cent.

Despite investor concerns that private equity investments are overvalued, this indicates that if anything, valuations are actually downplayed. 

The case for more positive investor sentiment around private equity is clear.

The conservative nature of valuations also means that private equity portfolios maintain more stable multiples across market cycles, rather than experiencing the sharp spikes and falls seen in public markets.

So, when questions are raised about why private equity valuations have not slumped to the same extent as public investments during volatility, it is in part because they were not inflated to the same extent during the bull market. 

The case for more positive investor sentiment around private equity is clear. But with the discount remaining wide, we believe that more needs to be done to educate investors on the nuances and benefits of listed private equity.

If historical misunderstandings can be addressed, the sector-wide discount should narrow as the true value of this investment proposition is recognised by the market.  

Colm Walsh is managing director of ICG Enterprise Trust