Accessing private equity

Private equity was once the preserve of high-net-worth investors – financial advisers with enthusiasm for the asset class found it difficult to access, other than on behalf of their wealthiest clients. No longer – around 25 listed private equity trusts provide access to the sector, offering either exposure to a portfolio of direct investments or a fund of private equity funds approach.

Analysis published this month by Money Observer magazine demonstrates just how attractive this route into private equity can be. Seven of the 14 investment companies in the private equity sector with a 10-year track record have outperformed both the FTSE All-Share Index and the MSCI World Index, the magazine points out – and often by a “handsome margin”.

It’s an investment idea also noted by Matthew Read, a senior analyst at QuotedData, who last week noted the unusually high discounts at which shares in a number of private equity funds have been trading relative to the value of their underlying assets. “It is hard to rationalise the sector’s discount and it would be nice to think that investors will take advantage of this chance to pick up some bargains,” Read told Portfolio Adviser.

Of course, advisers often worry about the issue of investment company discounts – the closed-ended structure of such funds inevitably means there will be times when their share price gets out of sync with the value of the underlying assets, resulting in a discounted or premium valuation. But while this has put some advisers off investment companies in the past, it’s worth thinking about why closed-ended funds are an ideal structure for private equity investment.

Above all, private equity can be an illiquid asset class, which proves problematic in an open-ended fund where the manager is having to cope with inflows and outflows of investors’ cash – often at exactly the wrong moment. Also, the valuation of private equity investments is not always straightforward, leading to lumpy performance that is difficult to manage outside of a closed-ended structure.

It also helps that investment companies have access to gearing, which is off limits to other types of collective investment vehicle, but which is a staple part of many private equity strategies. And even though this isn’t an asset class associated with income, several private equity investment companies do now offer enticing dividend payments, which they are able to fund from capital where shareholders have agreed – again, this wouldn’t be possible in an open-ended fund.

The choice on offer is attractive too. Some advisers will relish the diversification benefits that a fund of funds approach can bring, particularly in a sector where there is potential for significant losses on individual investments. Others will prefer the purity of direct investment, particularly as these funds may feature lower charges.

Either way, however, the bottom line is that closed-ended funds give advisers a well-established way to access a potentially attractive asset class for their clients, which would otherwise be off-limits. Private equity certainly won’t be suitable for all investors, but it’s valuable that those for whom it is appropriate no longer have to miss out. The long-term track records of so many funds are reassuring too.