How to invest with the dealmakers taking companies private

A stock market listing used to be something that growing businesses aspired to – a successful flotation was regarded as proof that the company had made it. Today, however, public listings are on the decline – both in the UK and the US. Fewer companies are opting for the IPO route in the first place; and publicly listed companies are being snapped up by investors, particularly private equity firms.

The latest such deal, announced in recent days, came in the US, where the sports and entertainment group Endeavor was bought for $13 billion by private equity firm Silver Lake. It had traded on the US market for just three years. In the UK, high profile “take private” deals in recent months have included acquisitions at logistics firm Wincanton, pharma company Ergomed and wealth manager Mattioli Woods.

For investors and their advisers, these trends have significant consequences – they limit their stock-picking choices. In the US, for example, there were 7,000 listed companies in 2000; today, the figure is 5,000. In the UK, there are now around 1,900 listed companies, down from 2,500 just 10 years ago. By contrast, the universe of companies with private equity and venture capital backers now runs to around 17,000 according to analysis from Edison.

All of which makes the struggles of private equity investment trusts in recent times even harder to understand. These funds are one of the few ways for ordinary investors to get exposure to that growing universe of privately owned companies without having to invest huge sums and tie up their money for years on end. The private equity investment trust sector offers a liquid route into the asset class, with access to high-quality managers, reasonable charges and the risk management benefits of a diversified portfolio.

And yet, the sector continues to find the going tough. Shares in almost all the 15 or so private equity-focused investment trusts currently trade at substantial discounts to the value of their underlying assets – valuation gaps of 20, 30 and even 40% have become commonplace.

Largely, this is a matter of sentiment. Risk-averse investors have become ultra-cautious – they worry that the stated asset values of funds are out of date and that managers will mark down valuations over time. The tough economic backdrop faced by portfolio companies must be taking a toll, they reason, even if this has yet to be made clear in public disclosures.

Fair enough. In the market environment of the past 18 months, such nervousness is entirely understandable. Investors – and their advisers – can be forgiven for steering clear of funds where they feel they do not have a clear picture of bad news that may be yet to unfold.
 

And yet, for the brave, this represents an opportunity. It’s worth saying there is little evidence of any substantial and across-the-board markdown to come. The whole sector has updated its valuations several times over the past two years – the period when sentiment has been depressed – without any hint of disaster. Indeed, many funds have been able to sell portfolio investments at prices above their valuations.

Moreover, a number of funds in the sector are now taking proactive measures to try to squeeze their discounts. Free cash is being allocated to programmes that automatically buy back shares when the fund’s discount hits a certain level. Such discount control measures can deliver an uplift even in the absence of an underlying performance improvement.

There is no silver bullet. But these funds have rarely looked so cheap. For investors and advisers disappointed by the ever-shrinking nature of the publicly listed markets, private equity investment trusts could be an excellent long-term opportunity to get into private companies instead.