Investors have dedicated a lot of attention to private equity trusts, for a variety of reasons. Like many alternative asset cohorts, the trusts appear to be cheap, with the majority of the names in the AIC’s Private Equity sector still trading on double-digit share price discounts to net asset value (NAV). These discounts are above 30 per cent in the case of ICG Enterprise (ICGT), Pantheon International (PIN) and HarbourVest Global Private Equity (HVPE).
The catch? That some investors still question the validity of the valuations given on such portfolios, and that future returns could well be materially lower in an era of higher interest rates and more expensive borrowing. As such, shareholders might be forgiven for ignoring discounts and asking just how much progress has been made when it comes to realising gains.
To look at one metric, in recent weeks we have seen a handful of private equity trusts, from HgCapital (HGT) to Oakley Capital Investments (OCI), announcing that they have successfully sold off assets, something that offers hope that funds can still shift holdings at a profit.
But things still seem a little tepid: Stifel analysts point out that the sector has had “a relatively quiet first half of the year, with the level of realisation actually slower than we had expected at the start of the year”.
Why has activity not ramped up, given that market sentiment more generally has been reasonably buoyant this year? The Stifel team believes that potential buyers of underlying companies might still be wary of the economic background, that they are cautious about making new investments in an era of higher rates, and that the initial public offering (IPO) environment remains pretty subdued, removing one route for trusts to sell out of investments.
It’s worth considering the case for hope here. Stifel’s team notes that, with it proving harder to exit positions, private equity teams have ended up sticking with their investments for longer and these companies have reached greater levels of maturity as a result.
They noted that private equity trusts currently have an average holding period of five to six years, while the Financial Times reported earlier this year that private equity groups were sitting on investments valued at a substantial $2.8tn, a record high.
By their measure, these longer holding periods (and greater maturity) mean the portfolios are, to use Stifel’s words, “pregnant” with potential asset sales. These sales may have been delayed because of the current uncertain environment but this could abate over time.
Stifel’s team adds that private equity portfolio managers are likely to come under pressure to sell more assets in the next year or two, especially when investments are held in partnership with another entity. Investment teams will also be keen to demonstrate good returns and to show that they can sell off assets at a good price. Conditions could also improve if interest rates stabilise or fall.
Optimism aside, this situation still warrants careful observation. Interest rates are likely to remain at a higher base than a few years back, putting pressure on the potential returns private equity can achieve from new investments.
The holdings they are currently looking to exit may also end up realising weaker gains than they might once have. Even with discounts looking excessive, investors might be forgiven a “wait and see” approach.
