My best investment - Andrew Lebus, Pantheon International Participations

Andrew Lebus, Manager, Pantheon International Participations

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With our emphasis on buying secondary interests in private equity funds, our best investments reflect the valuation and pricing anomalies that we can uncover through our broad coverage and access to a wide range of funds and private equity managers through our global investment activities.  Valuation anomalies can be found across the private equity industry, even during periods of high or rising valuations such that, in our view, average market discounts are a poor single predictor of investment outcomes.   The relationship breaks down for a myriad of reasons, but the key reason for this apparent anomaly is the degree of discretion exercised by each private equity manager:  despite fair market valuation methodologies adopted almost universally under international accounting standards, private equity managers retain significant discretion over how portfolio companies are valued.  There are discernible differences amongst managers in their approaches, often driven by their choice of comparable companies or the nature and extent of adjustments made to earnings measures.  Furthermore assets will often be held at cost for the first year of investment, even if significant performance improvements have already been achieved since the valuation date.  The valuation lag effects can be even more pronounced in the case of growth equity or late stage venture investments where revaluations may only occur after a specific trigger event such as a new financing round.

Given these characteristics, a well-connected and well-informed buyer has the potential to generate attractive returns irrespective of prevailing market conditions.  For example in 2012, Pantheon acquired an interest in a fund picked out of a larger portfolio.  The strong attraction of this investment lay in one of the portfolio companies which was held in the fund at a valuation of zero.  We formed the view that work being undertaken by the private equity manager in conjunction with the company’s management, restructuring the credit facilities and injecting new capital, integrating the acquisitions, bedding down revisions to customer contracts and streamlining manufacturing processes was likely to lead to a turnaround in the company’s performance.  By 2013 the company’s performance had improved dramatically allowing it to return 25% of the total capital invested in the business and in 2014 it was sold generating, in total, proceeds of more than 3 times the original cost.

While we can’t often expect to find such gems actually valued at zero, it illustrates how a well-informed investor in the private equity secondary market can take advantage of the differing approaches that private equity managers have within comparable fair market valuation policies.  Based on our experience some PE managers are slower than others to write-up portfolio company values following good news or market movements.