The puzzle of private equity?

Even when their valuations are validated by sales, listed private equity trusts continue to trade at significant discounts

In recent years, private equity has expanded quickly. According to data firm Preqin, private equity assets increased from £2 trillion ten years ago to over £6 trillion by 2024. The amount of venture capital increased by roughly £2 trillion, from 0 to 5 trillion in 2014.

Despite the fact that it sounds enormous, public markets are still much larger. Even though there are almost 25 times as many privately backed companies as publicly traded ones, the total size of private equity and venture capital investments, including funds of funds, is only about 12% of the size of public equity markets, according to private equity firm HarbourVest.

The returns have been good. According to Datastream and Deutsche Numis, private equity funds returned roughly 9% annually over the 25 years ending in 2024, with a volatility of roughly 10%. Over the period, the FTSE All-Share returned 5% annually with volatility of roughly 15%, while UK government bonds returned 4% annually with volatility of about 6%.

However, historical performance is not always a good predictor of future results, and there are indications that the lengthy boom in private equity may be coming to an end. The cost of the debt that is essential to funding leveraged buyouts rises with higher interest rates.

Managers are finding it difficult to sell their mature holdings onto public markets due to a lack of interest in private equity-backed initial public offerings (IPOs). This is partially due to the fact that many private equity IPOs have since underperformed.

Unwarranted reductions in private equity.

Nevertheless, investors shouldn't discount the industry just yet. Listed private equity trusts in the UK provide access to company portfolios and industries that aren't listed on the London Stock Exchange. For instance, HG Capital (LSE: HGT) owns a portfolio of companies in the tech industry, which is underrepresented in the UK market.

Despite evidence that suggests discounts are generally conservative, the majority of the sector is also trading at a significant discount to net asset value (NAV). To assign value to their portfolios, private equity trusts rely on internal procedures. Due to the highly subjective nature of the results, valuations are only validated upon asset sales. All of the major trusts did, however, sell their assets last year for more than their carrying values.

The premium for HarbourVest Global Private Equity (LSE: HVPE) was approximately 30%, while the trust's current discount to NAV is 33%. HG Capital's average premium was approximately 15%, compared to the current 8% discount. Despite a 33 percent discount, Pantheon International (LSE: PIN) managed to reach nearly 25 percent. The average exit uplift over the course of the five years was roughly 30%. With an average of almost 80 percent, HarbourVest was an anomaly.

Participating in the entire private equity market.

A diversified portfolio of trusts and listed managers is held by funds like Pareturn Barwon Listed Private Equity Fund and iShares Listed Private Equity (LSE: IPRV) as an alternative to individual trusts.

Bob Liu of Barwon says, "We believe that trusts and managers are very complementary and allow an investor to gain exposure to both sides of the equation i.e., the returns on the investments and both the management and performance fees the manager earns on its investments, despite the fact that they are fundamentally different." For managers who are becoming more and more focused on particular areas, industries, or market niches, this also offers diversified exposure.

Bulls contend that private equity assets are being undervalued by the market and will be acquired if discounts do not close, regardless of how you look at it. Petershill Partners (LSE: PHLL), a London-listed company under the ownership of Goldman Sachs, which supplies growth capital to managers and private equity firms, announced two weeks ago that it was going private as if to support this claim. Compared to its pre-announcement price, the buyout offer represents a substantial 35% premium.