‘Buy’ this private equity fund ‘pregnant’ with gains on old investments

Wide discounts on maturing portfolios mean there is a lot of value in the private equity sector right now, but one investment company really stands out.

This is a version of an article published this morning in the Telegraph’s Questor column.

Many people think of investing as buying shares in companies listed on public stock exchanges but there is a parallel universe of investments in private companies.

Worldwide, there are 39,000 private equity funds investing in startups and established firms, aiming to grow their businesses so they can be floated on the stock market or sold to a trade buyer or another investor.

Most of these funds require big sums to invest. On the London Stock Exchange though, there are 40 private equity funds whose shares can be bought easily like any other through a stockbroker.

I tipped one, the specialist early-stage investor, Augmentum Fintech (AUGM ), in December. However, these funds operate across a broad range of sectors and countries, either investing in companies directly or through other private equity funds.

The market is remarkably polarised. On the one hand is the giant 3i Group (III ) whose £18bn portfolio accounts for nearly half the £39bn in the sector. Its share price stands at a huge 31% premium above asset value, reflecting strong investor demand after it trebled shareholdersmoney over the past five years. 

The other 39 funds are rather neglected, their shares consistently stuck below net asset value (NAV) despite impressive long-term performance. 

Although none comes close to 3i’s incredible 776% shareholder return over 10 years, the average private equity ‘fund of funds’ hasn’t done badly with 232% while the average direct private equity fund posted a gain of 275%. 

These figures compare well with global public stock markets and are much better than the FTSE All Share index which returned 65%.

Despite this, private equity funds apart from 3i stand at an average 24% discount to NAV. 

There are several causes: painful memories of the 2008 global financial crisis, when some funds crashed; regulations that inflate these funds’ high charges and make them appear prohibitively expensive; and suspicion of the three-to-six-month delay in valuing their assets.

The latter has led to fears the funds could go over a ‘cliff edge’ with their stakes in unquoted companies written down in the challenging economic environment. 

City analysts believe that is unlikely because private equity-backed firms have continued to grow profits, while the stock market rally at the end of last year gives them a positive yardstick by which to measure their businesses. 

Private equity funds generate their returns by eventually selling stakes in their holdings, frequently on big uplifts to their previous valuation. Last year these ‘exits’ dropped off as buyers grew more cautious but could revive if interest rates fall and confidence returns.

Analysts at the broker Stifel said this pause left many private equity funds ‘pregnant’ with potential gains from investments made five or more years ago. ‘Assuming realisations at gains over prior valuations, this will help NAV growth’ and lead to higher share prices, they said.

Oakley Capital Investments (OCI), a £1.2bn fund of funds managed by technology, consumer and education investor Oakley Capital, is a popular analysts’ choice on a 30% discount and 206% 10-year return.

So is Pantheon International (PIN ), another Questor tip. The £2.2bn portfolio of funds and companies languishes on a 34% discount despite a £200m share buyback programme to boost shareholder returns and demonstrate confidence in its investments, a move that won it the ‘Best Board’ award from Citywire in November.

Broker Deutsche Numis this week tipped AVI Global (AGT ), an investment trust that holds nearly 18% in three private equity funds, including Oakley and Pantheon. With its shares on a 9% discount, it is also a good way to access a cheap sector.

Cheaper co-investor

But Questor’s current favourite is NB Private Equity (NBPE ), a £1bn investment company run by Neuberger Berman in New York, which has the pick of all the $120bn (£95bn) investments made by the group’s private equity funds. Its top holding and best long-term performer is the 6% invested in Action, the rapidly growing European discount retailer that has turbocharged 3i Group.

By co-investing almost all its portfolio directly in 86 private companies with 53 external fund managers, NBPE avoids shareholders paying two sets of fund fees. As a result, its 1.9% annual ongoing charge is lower than the 3.4% average of its closest rivals, according to Numis data.

It pays 3% of assets in dividends each year which, with the shares on a 28% discount, puts them on a 4.7% yield. Best of all, the maturity of the diversified portfolio – 70% of investments date back to 2019 or earlier – increases the likelihood of disposals this year.

Although these may not be as profitable as in recent years, they could pep up performance which has been modest in the past year, but over five and 10 years has delivered shareholder gains of 74% and 287% after all fund fees.

As its board steps up share buybacks, Paul Daggett, a Neuberger managing director, says NBPE is ‘well positioned’. I agree.

NB Private Equity key facts

Share price at yesterday’s close: £15.60
Market value: £721m
Year of listing: 2009
Discount: 29%
Average discount over past year: 29%
Yield: 4.7%
Most recent year’s dividend: $0.94
Gearing (Dec 2023): nil
Annual charge (Dec 2023): 1.9%

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