Private equity investment trusts offer dividends and growth at a discount

Private equity became a bone of contention over the course of the Covid-19 pandemic, with politicians among the critics warning of the wave of money being used to take listed British firms private.

Since the pandemic hit in 2020, 1,206 British firms worth £92billion have been snapped up by private equity, according to Refinitiv data.  

But while the private equity boom is highly controversial, it also provides an investment opportunity – and not just for high-rolling wealthy and institutional investors. 

Ordinary investors can buy in through private equity investment trusts, many of which have decent dividend yields, share price performance track records and trade at a discount.

In 2021, 773 UK private equity deals were done, worth a total of £63billion, up from 461 in 2019. The biggest was Clayton Dubilier & Rice’s £7billion deal for supermarket Morrisons.

Explaining this appetite, head of M&A at Peel Hunt Michael Nicholson said: ‘With the UK market viewed to be relatively undervalued, prospective acquirers have seen the opportunity to deploy capital on attractive multiples, with private equity investors sometimes applying a different view on risk to more conservative public market investors, especially in the context of Covid-elevated uncertainty.’

However, the private equity feeding frenzy has not been unique to the UK.

Globally, 2021 marked private equity’s first ever ‘trillion-dollar-year’, according to PwC, with the total value of acquisitions reaching $1.2trillion (£890billion) by the end of the year, up 96 per cent from 2020.

PwC explained: ‘The global economic rebound from the depths of the pandemic, widely available financing for deals, increased consumption levels [and] the growth in vaccination rates were all factors underpinning deal momentum throughout the year.’

Private equity is an asset class that is traditionally the preserve of institutional investors and the ultra-wealthy, with retail buyers effectively barred from investing in funds owing to prohibitive minimum investment levels and regulatory restrictions.

The Financial Conduct Authority is currently working towards the creation of a new investment vehicle for the British market, a Long Term Asset Fund, which will allow a greater pool of investors to access less liquid investments, including private equity.

But, for now, retail investors’ best bet for accessing the asset class is by buying shares in listed private equity investment trusts.

There are plenty of investment trust options, though, with 17 private equity investment companies available in the UK market, according to the Association of Investment companies.

Twelve months of prolific deal making proved positive for the performance of much of the private equity investment trust sector’s shares, with the average vehicle in the sector returning 23.8 per cent over one year compared to a 14.8 per cent return for listed stocks on the FTSE All Share index.

The sector is also a good source of income, with an average dividend yield of 2.79 per cent.

However, the sector has sufferedsince t he start of 2022 on worries about potential write-downs of investments following the sharp sell-off in growth stocks.

This has potentially provided a buying opportunity, though, with the average private equity trust siting on a 3.8 per cent discount to net asset value and just three currently trading at a premium.

In a note published at the end of January, analysts at Stifel said: ‘We think the recent sharp falls in prices and widening of discounts is already pricing-in quite a lot of bad news.

‘Therefore, with discounts to historic NAVs typically in the range of 20 per cent to 30 per cent, many of the funds do offer value at these levels, in our view.’

Head of funds research at interactive investor Dzmitry Lipski agreed that ‘on a relative basis, private equity trusts are still looking good value’, but cautioned that ‘valuation is a notoriously hard nut to crack in this sector’.

He added: ‘That said, yield and good long-term returns (and currently short term performance after a good year for the sector) are likely to make these trusts more popular with private investors – for now at least – especially at a time when we hear more about the benefits of alternative assets.

‘The market landscape is changing, with investors looking for asset classes with income and diversification benefits – at a reasonable price.’

However, for retail investors, interactive investor recommends the fund-of-funds model, whereby investment trust portfolio managers allocate small amounts of capital to dozens of private equity funds with different strategies.

‘This is a better approach for private investors for a niche asset class – we think it is best not to be over creative,’ Lipski said, citing the Standard Life Private Equity Trust as an example of a vehicle managed by a ‘highly experienced team’, with an ESG focus and a diversified portfolio.

Standard Life Private Equity is currently trading at a 25 per cent discount and paying a 2.7 per cent yield.

Another option available in the fund-of-fund model is HarbourVest Global Private Equity, which is currently trading at a discount of 22.4 per cent and its share price performance has beaten its average sector peer over one, three, five and 10 years.

HVPE’s Richard Hickman explained the trust provides ‘very broad-based exposure’, and is therefore ideal for ‘investors who want exposure to private markets but don’t have a particular view on the precise areas – such as venture, growth equity or buyout deals’.

He added: ‘There are fewer and fewer opportunities in the public markets to back faster growing companies, because they tend to stay private for longer these days.

‘There’s a growing private market industry, there’s more capital available off of the public markets, and in the last couple of years we have seen take-privates happening quite regularly.

‘There’s a whole ecosystem there that a lot of investors don’t have exposure to.’

For investors unsure about backing an investment trust purely comprising private equity, but who still want exposure to high growth unlisted businesses, there is the public-private approach.

Despite its recent well-publicised difficult run of form, Scottish Mortgage is probably the most well-known investment trust using this approach, with the vehicle investing up to 30 per cent of its assets in private assets. 

Alternatively, there are other investment trusts with long track records and a similar approach, such as F&C Investment Trust and Chrysalis Investments.

Explaining the benefits of this kind of approach, Uzo Ekwue and Tim Creed of the Schroder British Opportunities Trust wrote recently: ‘Both public and private equity investments can be attractive as standalone strategies.

‘However, we believe bringing them together in the same portfolio confers some important benefits.

‘These include access to a broader set of potential investee companies, the ability to invest at an early stage in a company’s existence, as well as enabling a wider perspective and consistency of stewardship.

‘We think all of this enables an investment team to create the best possible portfolio for clients.’