Pantheon tries to confound the discount doubters

“We are completely baffled and frustrated by the discount, and so is the board,” says Helen Steers, manager of private equity investment trust Pantheon International (PIN). As of 26 January, the trust was trading at a hefty discount to net asset value (NAV) of 44 per cent. As the chart below shows, Pantheon is not the only private equity trust in this position – the whole sector is looking cheaper than normal.

But there are reasons for this, one being that investors don’t trust asset valuations that have so far have held up better than those of public companies. Private company valuations are updated less frequently than their listed equivalents, which in tough times can mean sharp valuation drops on a quarterly or half-year basis.

When valuing their own companies, Pantheon's managers gather information on private deals across relevant sectors and analyse comparable transactions, rather than focusing on public equivalents. But this does not preclude the possibility of valuation falls, given the changing economic environment that all companies face.

“Often these companies are in really specific sectors, so it’s very difficult to find a public company [to compare],” says Steers. Private company comparisons are “more relevant for us than looking at some mega public company that may be very different to the specific company that you are investing in”.

Pantheon also looks at a company’s business plan, prospects for growth and exit plan. Historically, only a minor portion of the trust’s exits have come from IPOs and in 2022 the figure was just 7 per cent. Selling to trade buyers accounted for 49 per cent of the trust’s exits and selling to other private equity managers 42 per cent.

“One of the things we are always looking for when looking at a new company investment is: who is the natural buyer for that company?” explains Steers. “And how can we position that company to make it suitable for acquisition by the trade buyer?”

In Pantheon's case, its particularly wide discount may be partly to do with the fact that it - unlike many of its rivals - does not pay a dividend. Steers says the trust is focused on capital growth, but there are reasons to doubt that this growth will be as easy to come by in future now that interest rates are rising.

In the year to May 2022, the trust sold its assets at an average 42 per cent uplift compared with their valuations. Since 2012 the metric has never gone below the 20 per cent mark, but an age of higher interest rates could change that.

As of 23 January, Pantheon’s NAV was up 12.4 per cent year on year, while its share price was down 17.6 per cent. In the last three months of 2022, the NAV declined by 5.3 per cent. Most valuations for the funds the trust invests in date back to September 2022. Markets' rally since September is potentially good news for private equity valuations, although the pound’s recovery against the dollar is not quite as positive.

Like many in the private equity industry, Steers thinks that investors’ memories of how the sector performed in the aftermath of the financial crisis is another reason for persistent discounts. But at the time, Steers says, private equity was investing in consumer discretionary companies, while now the focus is on the information technology (IT) sector, particularly on the infrastructure side, which she says should make for a more resilient type of investment.

Pantheon currently has about a third of its assets in IT, followed by healthcare at 18 per cent and consumer at 14 per cent. Its 10 largest holdings include LifePoint Health, which provides a range of healthcare services to communities in the US; Visma, an accounting and payroll software provider in the Nordics; and Vistra, a financial and corporate services company based in Hong Kong.

Steer adds that the way private equity operates has changed compared with the early 2000s. “Fifteen years ago, managers were much more financial engineers and they had much less operational expertise on staff,” she says. “Nowadays, most of the best managers have very strong portfolio managers that are not thepeople doing the deals – they are the people that work with portfolio companies, and people that can help with things like supply chain management, digital marketing [and] human resources.”

During the financial crisis, the levels of leverage (debt) within the sector were also an issue. As interest rates rise, investors have legitimate reasons to ask how this will impact the industry in 2023. Steers points to the fact that Pantheon International’s highest exposure is to small- and mid-sized buyouts – 43 per cent of its assets as of 30 November – which tend to be less leveraged. Growth and venture capital strategies, which have zero or very little leverage, also play a significant part in Pantheon International’s portfolio. These accounted for 21 per cent and 3 per cent of its assets, respectively.

“I think the bigger concern is probably at the top end of the market with the mega deals,” says Steers. These have tended to have more debt placed on companies, although she adds that we have yet to see great levels of distress. Pantheon invests about a quarter of its portfolio in large and mega buyouts.

Concentrating the portfolio

Private equity investment trusts are typically categorised in two main groups. Funds such as Princess Private Equity (PEY) and Oakley Capital Investments (OCI) have more concentrated portfolios, which are directly invested in unquoted companies. And funds of funds such as Pantheon International and HarbourVest Global Private Equity (HVPE) offer high levels of diversification because they invest in other private equity funds and trusts, each of which has a number of holdings.

Perhaps counter-intuitively, it is the funds of funds that are trading at wider discounts on average – something that Steers finds puzzling because it could be argued that in a crisis a trust that is diversified across geographies, managers and sectors is a safer place to invest. On the other hand, funds of funds’ portfolios are less transparent so it is not always easy to see what companies they are ultimately invested in.

Classifying Pantheon International as a fund of funds is also a bit unfair, argues Steers. Since 2015, the trust has taken a ‘best of both worlds’ approach, and added more direct investments and concentrated the portfolio. These currently make up almost half of its assets, with the other half in funds from the US, Europe and Asia, as well as portfolios managed by names known to UK investors such as HgCapital.

Pantheon International’s managers use a “double quality filter” to select direct investments. They look for companies with managers who have a sustainable strategy for the future, excellent environmental, social and governance (ESG) credentials, and are good at incentivising their teams and keeping people on board. The company also needs to trade in a resilient sector, have an excellent return profile, a good management team, provide a clear value creation plan, and come with a clear exit strategy.

The level of control that this system enables is one of the key reasons Pantheon International has moved towards a more concentrated portfolio, says Steers. With direct investments, the trust is able to do due diligence on its companies, have better control over portfolio construction and ESG credentials, and save on costs.

Recession-proof?

One common criticism of the private equity industry is that it is not as transparent as public companies. Steers says that while managers are not always able to share information on private equity companies, they do have access to it themselves.

“I actually think we get a great deal more information in private markets than an average shareholder gets in public markets, ”she says.

Private equity managers have control or significant influence over their businesses and know them well. “The issue is that because the companies are private you can’t publish all that information,” she explains.

This also applies to ESG. The environmental side of investing is something “private equity probably hasn’t talked about enough in the past”, says Steers. Pantheon International’s companies are continuously monitored for potential ESG issues through an artificial intelligence tool that scans media, including social media, around the world. If something is raised by the alert system, Pantheon International’s managers can follow up with the underlying manager or company.

Even with conviction in her trust’s asset valuations and faith that the industry has learnt its lessons from the financial crisis, Steers still has concerns for this year. “I worry about inflation,” she says. “I worry about governments and central banks not getting it under control. I worry about wage-price inflation and the impact that could have on businesses and consumers.”

However, she adds, Pantheon’s businesses have pricing power, operate in resilient sectors, and often offer essential services such as healthcare or cyber security, which may protect them in a recession.

“We’re confident that our portfolio is resilient,” she says, “because we are invested behind these long-term trends. It’s not a fashion portfolio.”