The advantages of private equity

Investment companies don’t often top the news bulletins on mainstream television and radio, but private equity fund Better Capital has been a notable exception over the Christmas break. The fund has been forced to defend its stewardship of City Link, the deliveries business that went into administration on Christmas Eve, as well as the reputation of the wider private equity sector.

This isn’t the place to discuss what happened at City Link, but there is an important lesson for investors and their advisers here – putting money into a private equity fund is not a one-way street; there are bound to be setbacks along the way.

At the same time, it is important to remember why the private equity sector has played an increasingly important role in the asset allocation models of so many advisers in recent years. Not to forget large institutional investors, which are also increasing their exposure to private equity – one recent State Street survey of more than 130 large pension funds found that almost four in five plan to increase their holdings in alternative investments over the next three years, with private equity the most likely candidate for higher exposure.

The allure of private equity is straightforward: it offers investors exposure to fast-growing businesses at a far earlier stage of their development than most quoted companies. Moreover, the introduction of private equity investment can often be a crucial catalyst in the acceleration of that development – both because of the capital it makes available and the hands-on management it provides. Suddenly, young companies have access to both finance and new business experience, skills and networks. The results can often be dramatic.

For a long time, however, private investors weren’t able to share in that growth. Until the emergence of listed private equity funds such as Better Capital, the sector was the preserve of investors with the scale required to participate in limited-life partnerships.

The investment company industry has been able to change that. Better Capital is one of more than 20 listed private equity funds that offer advisers and clients exposure to their underlying investments in growth stories. Each of these funds offers access to a diversified portfolio of holdings managed by professional managers. They’re able to deploy gearing to enhance returns and to offer investors a liquid investment in which shares are traded day-in and day-out.

None of which is to say that private equity funds are right for all investors. As the City Link example demonstrates, this can be a risky investment – and a single failure can have a large effect on the fund’s share price.

Nevertheless, we shouldn’t lose sight of the bigger picture here. In a world in which advisers are working ever harder to provide clients with a diversified portfolio, alternative assets are becoming crucial elements of basic allocation models, alongside traditional holdings of equity and fixed-income instruments.

Private equity investment companies enable investors to turn those theoretical asset allocation models into a practical reality – to the enormous benefit of many clients, notwithstanding the occasional shock.

What the analysts say this week

Ewan Lovett-Turner, Numis Securities

“It is positive to see the board of JPMorgan Asian putting pressure on the manager to deliver improved performance and supporting it with a commitment to hold an additional continuation vote in early 2016. In January 2013, after a period of underperformance, the management of JPMorgan Asian was transferred from Singapore to the team in Hong Kong of Ted Pulling, Sonia Yu and Jeffrey Rosknell.

“At the time there was no fundamental change in approach, but the board hoped the change would boost performance. Since the change the manager, returns have been dull compared to the index, but strong recent performance mean that it has marginally outperformed with net asset value total returns of 13.1 per cent versus 12.3 per cent for the benchmark since January 2013.”

Ewan Lovett-Turner, Numis Securities

“JPM Brazil is currently trading at an 8.5 per cent discount, reflecting weak sentiment towards the asset class. The fund has an active buyback policy and repurchased 4.1 million shares in 2014, representing 7.6 per cent of the share capital. In addition, there is a provision that the fund will hold a 15 per cent tender offer at a 2 per cent discount to FAV if the discount exceeds 5 per cent over the 30 calendar days to 31 January and 31 July each year.

“The fund is currently sub-scale, with net assets of just £31m. In our view, however, there is potential for the discount to tighten significantly once Brazil comes back into favour, making it an interesting contrarian play. Other than JPMorgan’s in-house funds the shareholder base is dominated by private wealth managers and retail investors.”