Waiting to reap the rewards of tough times

"Because about 85 per cent of our assets are euro-denominated, foreign exchange can have a material impact," says Graeme Gunn, partner at SL Capital Partners Management, which runs the trust. "Up until November last year, we had around six years of [negative currency pressures] which was negative for our performance."

Despite this, the trust has beaten the average return of listed private equity fund of funds in NAV terms over one and three years, and broad indices such as the FTSE All-Share, although it compares itself to European indices as it is largely focused on this area.

Source: Winterflood as at 4 October 2016

Iain Scouller, managing director of investment funds research at Stifel, says: "We like the maturity of the portfolio, with around one-third of it having a vintage of five years and older, which suggests some good prospects for realisations in the year ahead. We also like the diversity of the portfolio."

SEP invests in other private equity funds rather than direct investments, focused on European mid- to large-cap buyout deals with high growth potential. During the second quarter the trust funded £12.3m of drawdowns from these and received £28m of distributions, which generated £13.6m of realised gains and income, equivalent to a return of 2.2 times the acquisition cost of the realised investments. It had total outstanding commitments to its funds' interests of £314.3m at 30 June.

Between 1 July and 27 September 2016, the trust funded £17.1m of drawdowns and received £17.6m of distributions.

SEP typically holds funds to maturity if they are performing well and meeting their investment target. "On a semi-annual basis, we consider if each fund will achieve the objectives we want, and if it looks as though they can't we will consider selling," explains Mr Gunn.

For example, the trust sold Apax Europe VII in October 2014 for £21.7m. "We didn't think this fund would perform and we got a good offer," explains Mr Gunn. "But it's actually very difficult to sell at a sensible price: for example, you may be able to sell at 60p in the pound, but is that real value for the shareholders? That said, if we are trading at a discount to NAV of, say, 25 per cent, there is some range in there you can sell at without destroying value."

Like many of its listed private equity peers, SEP has been trading on a double-digit discount to NAV over recent years, at times wider than 30 per cent. However, more recently, its discount has tightened to around 18 per cent in line with the general trend in its sector, due to a takeover bid for SVG Capital (SVI).

Mr Scouller thinks that "given the maturity of the portfolio and strong balance sheet, it is reasonable to value the shares on a 10 to 15 per cent discount to NAV and at this midpoint fair valuation is increased to 290p, from a previous level of 280p."

The trust was trading at around 277p as of 3 October.

In the second quarter, the trust committed €28.1m (£324.8m) to Sixth Cinven Fund, a primary investment (new fund), although it is already invested in other Cinven funds. It also committed €23m to Astorg VI, a mid-market fund run by a Paris-based manager it had not invested with before. Mr Gunn says France is an area they have been targeting for a while.

However, SEP is trying to cut the number of managers it has exposure to, and now 10 account for about 80 per cent of assets. And it is aiming to reduce the number of funds it holds from 49 to between 35 and 40.

"We have tried to hone down the manager relationships to a tighter group and cull the ones that have underperformed," explains Mr Gunn. "We are trying to make this portfolio more concentrated. If you have too many companies it is hard to shift yourself past the average private equity return."

SEP has exposure to around 400 companies via its funds, 45 per cent of which are in the industrial and consumer services sectors, with financials and consumer goods each accounting for 14 per cent.

The trust's managers have also been holding back from investing in anticipation of better-priced opportunities.

"We've had some opportunities to utilise the cash we've got sitting on our balance sheet, but we've held off because we feel that there's probably a better pricing opportunity coming in over the next six to 12 months," says Mr Gunn. "Our general view is that things are about to get tougher. When [the UK's withdrawal from the EU] starts to get sorted out it will undoubtedly cause some dislocations and volatility, and that's typically a time private equity does well. For example, the funds we invested in during the Greek crisis and coming out of the financial crisis in 2009-10 have done very well."

At 27 September 2016, the trust had cash and money market balances of £106.6m and outstanding commitments of £307.7m. Having a heavy weighting in cash as opposed to being invested means it is at risk of lagging behind its competitors and the wider market, as cash does not earn much. To mitigate this, SEP used to invest its cash in tracker funds to try to get a better return, but sold them on 8 July after they had generated income of £1.7m, for an overall realised gain of £2.3m.

This was because some of its shareholders feel it is the trust's purpose to put its money into private equity. "We welcome this disposal - while the aim was to reduce cash drag, we think this portfolio risked increasing NAV volatility," comments Mr Scouller.

For now the cash has been put into money market funds, but Mr Gunn adds that "the key for us is to get that invested".

But he won't invest in anything. One of his concerns has been the large inflow of money to private equity, because this means a fund can grow in size and may need to do bigger deals than it is used to. "So our biggest worry is that they are changing the strategy that they have been successful with in the past," he says. "The other question is whether the quality threshold goes down because of that. There's only two ways to invest a bigger fund - more deals or bigger deals. We've turned down a few funds lately because we feel they have raised too much money."