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A suitable structure

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22 November 2019

David Prosser explains the benefits of the closed-ended structure for investing in private companies.

The identity of the third most popular investment company with investors last month may surprise you. Data from Interactive Investor reveals crisis-hit Woodford Patient Capital was the third most bought investment company in October - only Scottish Mortgage and Finsbury Growth & Income saw greater demand for their shares.

Amid the collapse of Woodford Investment Management following the announcement that its flagship Equity Income fund is to be shut down, such high levels of demand for sister fund Patient Capital might seem peculiar. However, there are good reasons why the investment company has been so popular.

In part, investors have been motivated by tactical factors. The Woodford crisis had sent the fund’s share price into a spin, so when its board announced the appointment of Schroders to replace Woodford Investment Company, many investors saw an opportunity to get into Patient Capital on the cheap. They were opportunistic buyers.

However, other investors may also see the fund as a strategic long-term buy. They believe that the fundamental aim of Patient Capital – to offer exposure to small companies with the potential to be the growth stars of tomorrow –  is still an attractive one. From little acorns grow mighty oaks.

In fact, this interest in Patient Capital is part of a broader trend of increased investor attention on small businesses, including unquoted companies yet to make their debut on the stock market. The phenomenal success of the big technology companies, all launched within the past 10 to 20 years, has focused minds on the bountiful returns potentially on offer from getting in on a fast-growth company in its earliest days.

The investment company sector uniquely offers retail investors an opportunity to take these positions – via both the Growth Capital sector in which Patient Income sits and the larger Private Equity sector.

Indeed, the 20 or so funds in the latter group have democratised an asset class that was once off-limits to all but those investors with the deepest pockets. The limited partnership structures through which the private equity industry has traditionally operated require substantial minimum investments – often six or seven figures – typically ruling ordinary investors out of funds that have often delivered outsized returns. Private equity investment companies, by contrast, are available to all – you can even put them in your Isa.

The premise of private equity is an attractive one. Experienced investors make their capital available to businesses, alongside a slew of additional support, from specialist advice on strategy to access to new networks of customers. This combination of funding and practical assistance helps the business to realise its potential, generating attractive returns for all.

The key for smaller investors and their financial advisers eager to get in on the act is to identify the right structure for doing so. Private equity investments are fundamentally illiquid – they’re unquoted companies with lumpy revenues whose fortunes may wax and wane, particularly in the early days. That makes getting your money out difficult.

A closed-ended fund whose shares are traded on the open market gets round that problem. Investors can move in and out of the fund without any impact on the underlying portfolio; their money is always available, should they need access to it ahead of the five to 10-year time horizons over which partnership private equity structures typically plan for distributions.

Growth Capital and Private Equity funds, in other words, offer all the attractions of traditional private equity, but without the restrictions. That doesn’t mean, of course, that performance is guaranteed – that will depend on the choices made by the portfolio managers. But as so many investors concluded last month, the Woodford crisis should not undermine the case for this asset class, and an investment company can offer a route in.

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