Private Equity Investment Trust Discounts Widen

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Private assets investment funds have seen extreme gaps emerge between the valuations managers place on the illiquid assets in these listed vehicles and the prices investors are willing to pay.

The divergence has raised questions about whether trust managers are taking an overly optimistic view of their prospects amid dim outlook for economic growth and high inflation, or whether investors are missing out on possible deals if bad news is already a given. .

Private equity managers have thus far made only modest adjustments to the valuations of the illiquid assets they own, even as the share prices of companies listed on broader public markets are far below their peak levels.

Investors’ reluctance to pay the valuations reported by private equity managers is reflected in trust discounts – the gap between their reported net asset value (NAV) and their share price – currently ranging between 18% and 54%. %, according to Investec.

He calculated that the 14 largest private equity mutual funds (excluding 3i, which is a company rather than a fund) reported a combined net asset value of £17.3bn, but their aggregate market capitalization was only £11.1bn, creating a £6.2bn abyss on 23 May.

The average discount among the 14 private equity funds was 34%, compared to a 14% discount for the investment fund industry as a whole.

Investec analyst Alan Brierley said big discounts had become “built-in” in private equity funds, hurting the returns earned by investors. An obvious solution to addressing excessive discounting would be for boards to approve share buybacks, but most private equity managers appear reluctant or unable to pursue this option.

“A rethink is needed as the current discount management strategy has failed. Buybacks may provide some comfort at a time when there are clearly valuation concerns. Buybacks also provide liquidity and can dampen discount volatility,” Brierley said.

Nick Greenwood, manager of the £81m Premier Miton Migo Opportunities trust, which exploits mispricing across the mutual fund industry, said investor confidence had been damaged.

“Investors will believe that if this widening of discounts happened once, it can happen again. Managers have shot themselves in the foot with their failure in the past to address discounts. It will be difficult for private equity funds collectively to achieve significant discount reduction across the industry,” Greenwood warned.

The Migo Opportunities trust holds stakes in the Neuberger Berman Private Equity trust which is trading at a 33.7% discount and the Oakley Capital Investments trust which is trading at a 29.5% discount.

Neuberger Berman said the NBPE share price represents an “attractive entry point” and the discount on confidence “substantially underestimates NBPE’s portfolio, balance sheet strength and prospects.” In October, he gave investment bank Jefferies permission to conduct a buyback program, but so far no NBPE shares have been repurchased.

High fees for private equity funds with annual ongoing charges of up to 7% are also forcing sell-offs from asset managers, who are concerned about passing these costs on to clients. This is driving a vicious cycle of discounts.

“High fees for private equity funds mean they have become uninvestable for some asset managers and fund platforms. This has created structural selling pressure that is having a disproportionate impact on private equity fund discounts,” Greenwood said.

He acknowledged that investors were also concerned about trusts using inflated valuations that didn’t reflect the impact of higher interest rates on the earnings provided by highly leveraged private firms.

“We are only now seeing the disclosure of December 31 valuations for portfolio companies owned by private equity funds. These year-end valuations are verified by the big four accountants and this should reassure investors that the NAVs reported by private equity funds are increasingly realistic,” she said.

Brierley warned that further valuation adjustments are likely for private equity funds with significant equity exposures, such as Augmentum, Schiehallion and HarbourVest Global PE.

“Venture capital delivered spectacular gains in 2020 and 2021 as a tsunami of easy money from nontraditional investors drove valuations to mouth-watering levels,” Brierly said. She added that establishing a fair value for venture capital assets would be a “brutal” process.

Emma Bird, head of mutual fund research at Winterflood Securities, said investor scrutiny over private equity valuations was “completely understandable,” but some of the discounts were “excessive.”

However, private equity boards were reluctant to implement buyback programs as any excess cash was often reserved to meet working capital requirements and possible future drawdowns by investors, Bird said.

“But the downgrading of listed private equity funds over the past 18 months has spurred more frequent buyback activity. This demonstrates the boards’ confidence in the value their current share prices offer,” he said.

Brierley said he expects private equity strategies to continue to deliver superior returns and that the funds would attract the attention of hostile activists if the issue of excessive discounting was not addressed.

“Listed private equity can’t say it wasn’t warned,” he said.