Good entry point to private equity

It is also generally a good time in the cycle to buy into these trusts: valuations are high for sales of assets, and mergers and acquisitions (M&A) are at record levels. "As the portfolios continue to mature we would expect to see further healthy realisations," explains Alan Brierley, director at Canaccord Genuity.

Managers of the trusts are reasonably optimistic. For example, HgCapital's (HGT) managers believe the strong earnings growth and cash generation seen across the portfolio will continue to grow equity value: "A number of our investments are performing ahead of plan and we would expect these to return cash to investors during the second half of 2015. While several of our older investments could be realised now for good returns, we believe there is more to go for given their trading performance and market opportunity."

Global growth investment trust Witan (WTAN), which adopts a manager of managers fund strategy, has some direct holdings in private equity investment trusts. These include SVG Capital (SVI), Princess Private Equity (PEY) and Apax Global Alpha (APAX), which did an initial public offering (IPO) in June.

Andrew Bell, chief executive officer of Witan, says economic growth in major economies has been very steady, which should provide a tailwind for profits growth and asset values in private equity. With discounts widening, Witan has taken the opportunity to top up some of its private equity holdings, including SVG Capital.

Historically, private equity has performed better than listed equities and since March 2009, after the worst of the financial crisis, private equity investment trusts have risen 284 per cent against 112 per cent for the FTSE All-Share, according to Winterflood.

In more difficult markets these trusts' NAVs can be relatively defensive. This was the case in 2008: although share prices plunged, on a number of trusts the NAV held up much better, and also performed much better than broader markets such as the FTSE All-Share and FTSE 100.

Taking Electra (ELTA) as an example, over calendar year 2008 this trust's share price plunged 63 per cent when the FTSE All-Share fell nearly 30 per cent. However, Electra's NAV only fell 12 per cent over the same period.

"The portfolio losses, with the exception of some high-profile implosions, were much less than the losses for quoted equities," says Mr Brierley.

But this, of course, caused their discounts to NAV to widen considerably.

During the financial crisis a number of private equity investment trusts had high levels of debt and some had made more commitments than they could fund, most notably SVG Capital. This meant some of them had to resort to extreme measures such as rights issues – asking their shareholders for cash – which had a detrimental effect on their share prices. But private equity trusts now typically do not have such high levels of debt or unfunded commitments. They are also typically not overcommitted to investments.

Many companies have net cash and medium-term debt facilities in place in case of need, while the maturity profile of the underlying portfolios is increasingly attractive, adds Mr Brierley.

By investing in private companies via these trusts, you can also gain access to a much larger universe of opportunities worldwide than can be obtained through public markets.

Choosing a private equity trust

There are two main types of private equity investment trust: those that invest directly in companies and those that invest in other private equity funds. Funds of funds are typically lower risk because they have exposure to thousands of investments, rather than tens or hundreds. Directly investing private equity investment trusts can have a high concentration of investments, so if one goes wrong it could have a significant impact on returns. However, funds of funds do not get as much uplift from a single realisation as a directly investing fund.

Funds of funds can have higher charges because they involve a double layer of fees: at the trust level and on the underlying funds.

There is wide divergence between the best and worst performers so picking the right trust is very important. You should consider past performance, the track record of managers, and how long they have been working in this area and what their experience is.

Maturity of a trust's portfolio is very important: if you get a lot of investments of four years old or more there should be scope for exits.

Mr Bell also says that you should look at a trust's debt levels, what its policy on this is and how prudent it has been in the past. You should also check the level of outstanding commitments and cash levels.

Check how many underlying investments it holds, especially with a direct trust: if this is very concentrated this raises the risk.

Other things to consider include geographic and sector exposure, and the kind of deals it makes, for example, venture capital or buyouts.

Because of the high risks advisers suggest you hold private equity investment trusts as part of a diversified portfolio, and that they do not account for more than 10 per cent. You should also have a long-term investment horizon of at least five years.

Best opportunities in private equity trusts

Winterflood's main suggestions are Standard Life European Private Equity (SEP) which we also count among the IC Top 100 Funds, and Electra Private Equity.

Standard Life European Private Equity invests in European funds focused on mid and large buyouts with enterprise values of between €200m and €2bn. It has a strong long-term performance record and while more recent NAV performance has been adversely impacted by foreign exchange movements, the portfolio has been performing well.

"The mature portfolio remains cash generative, with realisations typically being achieved at uplifts to their carrying values," says Winterflood. "However, the managers continue to invest, providing a source of future NAV growth. Around 38 per cent of the portfolio is invested in deals that are more than five years old."

The discount to NAV is about 24 per cent, which is wider than its 12 month average of 18 per cent. "This offers some value relative to peers and downside discount risk is limited by the fund's buyback programme," adds Winterflood. "The fund is a sensible choice for investors seeking mainstream private equity exposure."

Electra has a strong long-term performance record with returns well in excess of the FTSE All-Share. It invests both directly and in other funds. "Although the portfolio is relatively immature we quite like the style: the flexible mandate is attractive," says Mr Urquhart. "And the discount offers reasonable value."

However, a large activist investor called Sherborne holds around 30 per cent of Electra's shares: if it gets much more it will have to take over the trust. Although in 2014 Sherborne failed to make the changes it wanted to Electra's board it has continued stake building, and following the pressure Electra cut its fees and introduced a policy of returning cash to shareholders.

Another risk is if Sherborne decides to sell its stake as it owns so much it would have a downward effect on the share price.

Mr Brierley likes Pantheon International Participations (PIN) which invests in private equity funds and we also count among the IC Top 100 Funds. "Pantheon remains our core recommendation for global private equity exposure," he says. "We expect a highly diversified and mature portfolio of conservatively valued companies with superior earnings and revenue growth characteristics to continue to deliver attractive risk adjusted returns. Meanwhile, a strong balance sheet represents solid foundations for further progress. We believe the depth of resource and network of contacts, combined with an almost unparalleled experience of the secondary market gives Pantheon a strong competitive advantage."

The trust trades at a discount to NAV of 18.8 per cent, wider than its 12 month average discount of 16.6 per cent.

"There are a number of listed private equity funds that we rate highly and believe appear attractive on current discount levels," adds Winterflood. "The ones that we would highlight include HgCapital Trust, Graphite Enterprise (GPE), and NB Private Equity (NBPE)."

HgCapital invests directly in private companies rather than in funds. It focuses on technology media and telecoms, services, industrials and renewables, mostly in the UK and northern Europe.

"HgCapital has an excellent track record and offers a bit of value at the current discount," says Innes Urquhart, analyst at Winterflood.

This trades on a discount to NAV of 17 per cent against its 12-month average of 13 per cent. However, it has a high ongoing charge of 2.46 per cent.

Graphite Enterprise is on a discount to NAV of about 17 per cent, against a 12 month average of 15.7 per cent. Its long-term performance is good, although it has not done so well over shorter periods. It typically has around three quarters of its investments in third party funds and co-investments, with the remainder in funds run by Graphite Capital.

HarbourVest Global Private Equity (HVPE) may also provide discount tightening opportunities because it has recently moved its listing from the Specialist Funds Market to the main market. It has performed very well beating its peer average over one, three and five years in terms of its share price.

It is currently on a discount to NAV of about 17 per cent.

Performance of private equity investment trusts

Source: Morningstar, *Winterflood

Performance: Morningstar as at 10 September 2015