Is now the time for private equity?

Now might not be the most obvious moment to consider an investment in private equity. Privately-owned businesses tend to be smaller – often early-stage – and are generally considered more risky than stock market-listed companies. With markets worldwide more volatile than ever, and the US in bear market territory, why would advisers and investors seek to increase risk?

The answer, say analysts at Numis Investment Companies, is that listed private equity funds are less risky than is often imagined. Indeed, they might just be a good place to look for resilience amid the current turmoil.

Numis is focused specifically on the 15 or so investment companies in the AIC’s Private Equity sector. Traditionally, private equity funds, sometimes known as limited partnerships, ask for very large minimum investments – often, they are invite-only – and require investors to lock their money up for an extended period. That puts them out of reach of the vast majority of retail investors. However, the investment company structure provides a liquid way into this asset class – since private equity investment companies are stock market-listed, shareholders can get in and out as and when they wish, with no minimum investment.

Right now, Numis’s analysts believe these funds have three features that make them worth considering. First, they point out, “the approach of listed private equity funds leads to a bias to businesses that can deliver consistent earnings and revenue growth in a range of economic conditions”.

This is the resilience point. While these funds do invest in smaller, privately-owned businesses, their managers tend to avoid companies that are highly vulnerable to the economic cycle. Most funds operate to a model of investing in a business, holding on to it for a period while working with it to increase value, and then selling at a profit; they don’t want to be stuck holding businesses for longer than expected because their valuations have been depressed by economic headwinds.

This is not to say that the businesses held by these funds are impervious to the environment in which they offer. But there is good reason to hope they will prove more resilient than many other companies.

Valuation is the second attribute that Numis identifies as supportive. Right now, shares in most Private Equity sector funds are trading at substantial discounts to the value of the underlying assets. With unquoted companies – unlike listed shares where the market provides a continually updated valuation – valuations are updated periodically, so investors worry about writedowns when times are difficult. But the current level of discounts provides plenty of room for downwards adjustments; it may well be that investors are overestimating the scale of the bad news to come.

Factor three is manager quality. The nature of private equity investment, where the manager must work hand-in-glove with each company in the portfolio to drive operational and strategic improvements, means that the skill of managers in this asset class is of paramount importance. In the case of the investment companies, “the listed sector provides a pre-filtered universe focused on high-quality managers which should give investors comfort to take the plunge”, says the Numis team.

These are interesting arguments. For advisers and investors looking for safe haven assets in these troubled times, private equity would not necessarily be the first port of call. But investment companies offering a liquid way into the sector might just offer more security than you might expect.