The rise and rise of private equity
Much has been written about alternative asset classes over the past decade, and it’s easy to see why. With bond yields at all-time lows, interest rates either near zero or negative, and equity market returns expected to be lower in the years ahead, investors have been seeking alternative asset classes that can deliver attractive returns. Private Equity has been one of the main beneficiaries of this rotation.
Since 2010, private market assets under management have grown substantially, rising by US$4 trillion to a total of US$6.5 trillion, with a 10% increase in 2019 alone. Of that total, private equity accounts for the lion’s share, at around US$3.9 trillion globally. For many observers, this comes as no surprise. In the US, the number of companies listed on the stock exchange peaked at around 7,400 and since then has fallen by more than half. Conversely, the number of privately held companies backed by Private Equity in the US accelerated to around 8,000 by 2017 according to McKinsey.
As the private equity sector has expanded and larger amounts of money have been allocated to buyouts, the market has gone through a transformation. No longer is this a niche sector cloaked in mystery – its mainstream. Private equity assets have been growing at a faster pace than equity markets, and this has drawn in large investors that traditionally avoided the asset class.
Traditional private equity companies, however, remain out of reach for most investors. They have high barriers to entry, are a difficult asset class to navigate, can be quite expensive and often come with a high degree of risk. In addition, investors’ funds are often locked in for long periods to allow managers the leeway they need to transform companies and create value from their holdings.
This is where listed private equity companies come in. Structured as investment trusts, listed private equity companies provide access to this asset class through shares traded on the stock exchange and investment income and capital gains within the trust are not taxed. A critical feature of listed private equity companies, like all investment trusts, is that their share prices do not always reflect the underlying net asset value (NAV) of their portfolios. In cases where the share price has fallen below the NAV, it is trading at a discount and can therefore represent an attractive time to make an investment.
Finding their place in a portfolio
Private equity funds have stood out as having a potentially lower correlation to traditional asset classes as well as the prospect of potentially higher returns. Unlike unlisted private equity firms, which often have lock-in periods from investment and will only accept funds from a select few, listed private equity companies are transparent and their shares generally have good liquidity. Offering a degree of diversification away from traditional asset classes while offering the prospect of higher returns, they represent an attractive prospect for any investment portfolio.
There are several qualities that make listed private equity attractive. As private markets have grown at a global level, this has translated to a larger opportunity set for managers, enabling them to invest in higher quality companies and diversify their holdings across sectors and geographies. In addition, the increasingly sophisticated approach to integrating environment, social and governance factors into investment processes means companies benefit from the potential operational and performance enhancements.
In this sector, one of the main attractions for many investors is the prospect of higher returns in exchange for the added risk involved with investing in unlisted companies. Because of this, we believe it is best to gain broad exposure to private equity markets through investment trusts that take a fund of funds approach, as opposed to more focused funds that may come with greater risks.
As with any investment vehicle, listed private equity has its drawbacks and this is why we believe it should only represent a small portion of a well-diversified portfolio. During periods of market stress, listed private equity funds can become highly volatile and difficult to trade. When markets fell sharply in early 2020 due to the coronavirus pandemic, listed private equity companies were not immune. As a result, many of them are trading at deep discounts to their net asset value – some 20% or more. For those companies that continue to have solid fundamentals, this can create an attractive entry point for investors.
The good news for listed private equity is that, unlike the 2008 financial crisis when these companies experienced a torrid time due to their use of leverage, they have stronger balance sheets and more diversified portfolios.
There are clear benefits to investing in private equity over the longer term. Long outside the scope of private clients due to high costs, illiquidity and volatility, the asset class has learned from past failings. Listed private equity offers the opportunity for private clients to participate in a diversified portfolio of unlisted companies, otherwise available only to large institutions.
By adding listed private equity to a portfolio, investors gain access to private assets and strategies not available in the public markets. Over the longer term it would be expect that this allocation would boost returns, enhance yield, and improve portfolio diversification. Preferring to allocate to real assets over absolute return funds for a portfolio’s alternative investments, we expect listed private equity to continue and grow as a key allocation with this asset class.
Author: Eoin McBennett, Investment Manager at Quilter Cheviot, https://www.quiltercheviot.com
Quilter Cheviot Europe Limited, trading as Quilter Cheviot and Quilter Cheviot Investment Management, is regulated by the Central Bank of Ireland.
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