Last week I caught up with Paul Daggett, one of the managers of NB Private Equity (NBPE ), as he visited investors in the UK on a trip from his Dallas base.

I get a sense that after many years of being unfairly overlooked, listed private equity funds are seeing light at the end of the tunnel. There is hope that, as the UK government encourages pension funds to back unlisted companies with its Mansion House Reforms, there might be some change in mindset from those with an irrational dislike to private equity. After all, private equity is much more than just financial engineering and investors who shun these funds are missing out on great returns.

NBPE can boast annualised investment returns of 14.8% per year over the past 10 years, which makes it fourth best in the sector behind Abdrn Private Equity Opportunities (APEO ), HarbourVest Global Private Equity (HVPE ) and HgCapital Trust (HGT ).

That also puts it in the top 10 closed-end funds over the same period and miles ahead of the MSCI World index having grown the underlying net asset value (NAV) by 202% over the 10 years to 30 October, versus 118% for the benchmark.

Its share price returns are even better, reflecting some narrowing of its discount over that period. Yet it still trades on a 26% discount.

NBPE’s portfolio is now almost all (93%) invested in co-investments – slices of deals that private equity firms are doing. The great advantages of these are that they come with no underlying fees or performance fees, and they make NBPE’s balance sheet management much simpler – it does not have significant uncalled commitments to limited partnership funds to worry about. NBPE also points out that it can offer far greater insight into its portfolio than a fund of funds typically would.

Fund manager Neuberger Berman (NB) has assets under management of about $120bn and a big global team of over 300. It invests in all types of private equity and debt and makes primary commitments to traditional limited partnership funds as well as making co-investments. That means that it has good relationships with about 280 managers that are leading private equity deals.

NB is able to write tickets of $200m–$300m, with NBPE contributing about $20m–$30m of that. Consequently, NBPE is focused mainly on mid-sized deals in the US and Europe, with lesser exposure to larger deals. The portfolio is diversified with 85 direct equity positions, but not hyper-diversified in a way that a fund of funds would be with hundreds or thousands of underlying holdings.

Asset allocation is driven by bottom-up stock selection giving it a high 72% exposure to the US, which can make NBPE and funds like it a good way of getting exposure to mid-sized US businesses in a way that the UK investment companies sector is otherwise lacking. It is also quite well-diversified by sector.

Given its firepower and the long history of making co-investments since 2006, the lead managers on the deals bring NB in at an early stage. NBPE can decide quickly whether it wants to get involved or not and reject deals without compromising relationships. The typical rejection rate is about 85%-90% of all deals that they are asked to look at.

As interest rates have risen and credit has become harder to obtain, more co-investment opportunities are being made available and on more attractive terms. Daggett says that he and his team have been offered around 11 potential deals a week in recent months against about seven deals a week five years ago.

Despite higher interest rates, Daggett says that they are still targeting gross annualised returns of 24% from new investments. The key to achieving this is by driving revenue and earnings growth within the underlying business. This is the same message that I have heard from a number of other managers of UK-listed private equity funds, such as Oakley Capital Investments (OCI ), for example.

It is worth noting that NBPE is not much worried about the ability of its existing investments to cope with higher interest rates. Its businesses on average generate profits that are 2.6 times bigger than the interest payments on their borrowings, and most of those debts mature after 2027.

NBPE’s largest underlying position – European discount supermarket chain Action – may be a familiar name to many investors in listed private equity. It has long dominated 3i Group’s (III ) portfolio and features in a few competing funds’ portfolios. The position size reflects its success. NBPE put about 3% of its portfolio into the company in 2020 and, despite having trimmed it recently, it is now about 6% of the fund. Most private equity investors wax lyrical about it.

Other investments include USI, an insurance and employee benefits business that KKR bought in 2017 and has been growing through making bolt-on acquisitions; Osaic, a brokerage firm formerly known as Advisor Group that is backed by Reverence Capital; Solenis, a speciality chemicals business that Platinum Equity acquired in 2021 and has also been growing through M&A; and Constellation Automotive Group, the largest online second-hand car marketplace in Europe, which is backed by TDR Capital. Its brands include WeBuyAnyCar, BCA and Cinch. Those five companies accounted for 21.6% of NBPE’s portfolio at the end of October.

NBPE pays two dividends a year, distributing the equivalent of 3% of assets at its financial year-end. Because the board was keen not to cut the dividend when net asset value dipped last year, the payout is a bit higher and the shares yield i4.5%.

But what about the charges? Well, at 1.5% of NAV, the management fee is on the high side, but there is a bit more work to do here than there would be with a listed equity portfolio. The ongoing charges ratio works out at about 1.9%. There is a performance fee – 7.5% of gains over a 7.5% per annum hurdle, with a high watermark. Before you use that as an excuse not to invest, remember that NBPE’s impressive long-term returns are all quoted after fees. Why cut off your nose to spite your face?

James Carthew is head of research at QuotedData.

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