Private equity's road to recovery

Private equity is regarded as the lifeblood of high growth companies and businesses undergoing restructuring, but last year the sector sank into the doldrums, as the scarcity of bank debt and doubts over the ability of existing investments to survive an economic downturn raised concerns over whether private equity funds would meet their outstanding commitments. However, a year on and the private equity market is slowly starting to show signs of life.

"Most funds have addressed the stresses on their balance sheets, certainly in the short term, through fund-raisings or strategic disposals. Across the industry, investment activity remains low, but there are some encouraging signs and the general expectation is that investment conditions will be good from 2010," says Simon Elliot, analyst at WINS Investment Trusts.

Alan Brierley, director of investment companies at stockbroker Collins Stewart, agrees that with the dust now settled investors should take the time to re-assess the sector. He suggests fund of funds, Pantheon International Participations (PIN), as an attractive buy.

"Pantheon has recovered following the most traumatic of periods, in which its share price fell by 86 per cent. Notably, the feared collapse in net asset value (NAV) has not materialised; this reflects the fund's focus on top quality managers, the relatively low-risk nature of the underlying portfolio and the lack of exposure to mega-cap private equity," says Mr Brierley.

Established in 1987 and managed by Pantheon Ventures, PIN's primary investment objective is to maximise capital growth by investing in a diversified portfolio of private equity funds and occasionally directly into private companies.

The fund invests with leading private equity managers in the US, Europe and Asia, seeking to reduce investment risk through diversification of the underlying portfolio by geography, manager, maturity, investment stage and sector.

The underlying companies in the portfolio will range from large and mature industrial enterprises with multinational operations to early-stage ventures operating at the leading edge of technological development. Currently, the fund has a bias towards more defensive industries and, while buyouts represent around two-thirds of the portfolio, there is a focus on the mid-market with exposure to mega-cap buyouts low.

The past year has seen a significant improvement in PIN's funding position, with commitments falling from £733m to £390m, but despite the fund's exceptional gains in recent months, balance sheet concerns has PIP trading on a 60 per cent discount - the widest in the sector.

During the 10 years to 30 September 2009, however, the compound NAV total return for the fund was 7.3 per cent, comfortably ahead of annualised total returns of 2.5 per cent and 3.6 per cent from the FTSE All-Share and global growth sector. Mr Brierley adds that while there is scope for modest NAV growth in the short term, he expects a re-rating to be the key driver of returns going forward.

Investors, however, need to be wary of the fact that with 72 per cent of PIN's funds reporting in US dollars, the NAV will be impacted by the value of sterling.

While the private equity sector is still vulnerable to economic turbulence and plagued by questions over the ease of refinancing existing debt, Mr Brierley believes that concerns over Pantheon's over-commitment levels have now been addressed. He adds: "The current rating reflects these historic problems and not the potential for the manager to extend a long-term record of superior returns."

Key fund data:

Source: Thomson Datastream, AIC

Notes: Performance figures as at 24 November 2009

Investments as at 30/06/2009

Geographical Exposure