Steven Tredget, partner at Oakley Capital, Richard Hickman, managing director at HarbourVest and Andrew Lister, manager of the abrdn Listed Private Capital Fund discuss the options for investors looking to invest in private equity with Philippa Aylmer.
Private equity investing, once the bastion of institutional money, is becoming a valuable and viable asset class for the private investor. The consistent out performance of private equity over the last decade makes it is easy to see why allocating this asset class to an investment portfolio could significantly enhance returns. A recent report published by Preqin found that private equity returns achieved a net initial rate of return (IRR) of 18.8 per cent over the five years to March 2021 and in the three years to December 2021 LPX Europe was up 40 per cent.
Private equity funds expanding access
One of the main drivers for this has been an increase in the number of listed private equity managers and listed investment vehicles. It is now possible to buy shares in listed private equity firms such as Bridgepoint or EQT Group – essentially buying a piece of the whole company, similar to buying shares in Shell or Unilever. Or one can buy shares in a listed private equity investment trust, like Oakley Capital Investments (OCI) or Hg Capital Trust- this is a single manager ‘play’ and in this case you are buying a sliver of the underlying portfolio of private companies the trust invests in.
Another option is to buy shares in a listed fund of funds vehicle such as HarbourVest (HVPE) – this is a more diversified option offering exposure to lots of private equity managers.
Listed private equity managers have, of course, been around for a while, although according to Steven Tredget, partner at Oakley Capital, a mid-market private equity investor which manages a total of EUR5 billion, one main catalyst was the successful listing on Nasdaq Stockholm of EQT Group in 2019. “The listing has been a roaring success,” says Tredget. “EQT is a consistent outperformer, has around EUR71 billion under management, and as its rating has grown, it has attracted more and more managers to come to market.”
Since then, there have been a number of high-profile listings. Bridgepoint Advisers listed last year and is now valued at USD2.5 billion and TPG listed earlier this year with a valuation of USD10 billion.
Alongside this, the trend towards investing in listed private equity investment trusts and listed funds of funds continues to grow. Tredget adds that it is down to the pull effect too. “For example, OCI which has a net asset value of GBP961 million, has around 13-15 per cent retail ownership, which has more than doubled since pre- Covid.”
HarbourVest Partners’ listed vehicle, HVPE which has a net asset value of USD3.6 billion at 28 February 2022, also has around 14 per cent of its shareholder base in retail. Richard Hickman, managing director at HVPE explains that the growth of the listed private equity sector is largely due to improving the quality of disclosures and providing more transparency – for example, how a portfolio works and how investee companies within the portfolio operate. “I think the private equity market is responding in a similar way to the infrastructure industry through investment trusts for example.”
Private companies opting out of public markets
This ‘retailisation’ or democratisation is also combined with the fact that private companies are staying private for longer. Essentially retail investors have less access to fast growing companies on the public market.
“There is an increasingly strong narrative around companies staying private for longer. Investors still have broad exposure via different vehicles to public markets, but ultimately it is the same pool of companies that are available. On the private markets side, it is a totally different population of companies which is why investors are looking more towards this space,” adds Hickman.
According to Tredget, in the US the number of public companies is falling – currently around 18,000 private-equity backed companies and around 14,500 public listed companies: “Going public can mean more regulations and restrictions. It also means shareholders go from a few people to possibly thousands. Plus, the near-term pressure of live pricing can also be an issue, encourages ‘short-termism’ and distracts from the company. It is harder for public companies to take a long-term view.”
Whether one invests in the private equity firms themselves, a listed single manager vehicle or a listed fund of funds, any private equity manager must show a consistent track record and says Tredget, “the growth rate should be better than one can get from a company in the broader public markets.”
But he also recommends finding out whether the performance is repeatable. By this he means origination and growth. “For us it is about unearthing opportunities which no one else can find – 90 per cent of our deals have never been backed by private equity before. And regardless of the economic environment and geopolitical uncertainty, these managers should have a value creation strategy. They should have a structural tailwind behind them.”
Tredget recommends that managers look for a sector that is less available in the public markets or that is countercyclical. “Education is hard to access in public markets. It is like healthcare was 10 years ago.”
Hickman believes that funds of funds are a good starting point if you want a broad-based fund that invests across much of the private markets opportunity set. He also thinks that investors should explore whether a manager is being selective enough and to check the proportion of deals completed relative to those evaluated. And particularly important for closed ended funds, adds Hickman is to assess the balance sheet strength – and its overall cash flow and credit line management. “That was a key issue during the financial crisis,” he says.
Hickman explains that the team at HVPE look at diversification in three key ways: stage (early venture through to late-stage buyouts); geography, and strategy (primary and secondary) Investors should also consider vintage year diversification. “It is worth finding out how much of a private equity manager’s portfolio is in a particular vintage; a broad spread for your first allocation could be considered beneficial.”
Andrew Lister, manager of the abrdn Listed Private Capital fund, states that while the private equity universe is not huge, particularly in the UK, it is worth remembering that each private equity manager is different and there are different sets of risks between large and established managers versus the smaller ones. “It’s worth reading around each of those areas, find out their risk profile and how easy it is to get a handle on them.”
In the last few years, a new range of funds has emerged: a hybrid between a closed end listed fund and a traditional LP and GP structure that is completely private. It is semi liquid so it is possible to invest regularly and there are scheduled quarterly investment and exit periods. As long as the total demand for liquidity from investors is below a certain threshold – usually 5 per cent per fund – it is possible to sell a holding.
From a fund manager’s perspective, Lister’s fund, with GBP93 million under management invests in a mix of both single managers and funds of funds. LPC invests mainly in private equity but also in private credit, infrastructure and real estate.
“Single managers are the largest allocation within LPC’s private equity allocation. But we think funds of funds give you something different – a diversified exposure and for someone who is new to the space, it is a lower risk way of accessing the whole market,” says Lister.
Fees should not be an obstacle
One issue that comes up time and again is fees. For this reason, some wealth managers are reluctant to add private equity to their client portfolios. Private equity funds charge a much larger absolute amount of fees than one might pay to a public equity manager. Often there is a management fee of between 1.5 to 2 per cent, then a performance fee of typically 20 per cent over an 8 per cent hurdle.
“A lot of investors these days seem to be taking a barbell approach in their portfolios, using commoditised low-cost ETFs for mainstream public market asset classes and then being willing to pay higher fees to access highly actively managed private equity funds,” says Lister, adding that “for us it is about marrying up costs with performance. We are happy to pay for a manager that delivers excellent performance with commensurate risk.”
“Some funds might incur higher fees compared to a traditional equity fund. But with returns often around 35 per cent and a team of experienced investors behind the scenes, the costs should be seen in a different light,” says Tredget.
“Whatever happens,” adds Lister, “this it is not an asset class that is going to become cheaper. If you buy the cheapest option, you are potentially getting something inferior.”