The average private investor probably associates private equity with obscene levels of compensation, concerns about a business model that loads debt on to private businesses, or both. Valid criticisms – but if you let them put you off the sector entirely, you’re missing a trick. Firstly, private equity offers a great chance to invest in private firms whose managers have strong incentives to improve operational performance and grow the top line. Secondly, the UK market offers what is probably the best range of private-equity funds in Europe.
Finally, with British and European growth improving, and rising merger and acquisition activity, now looks a good time to invest, particularly as several of the listed private-equity funds have been neglected by investors in recent times.
The boring choice…
So what should you buy? The ‘boring’ choice, which we’ve mentioned before, is Pantheon International Participations (LSE: PIN). This long-established fund focuses on both primary investments and dealing in the secondary market. It’s on a stubbornly high discount to book value (currently around 18% – in other words, you can buy £1 worth of assets for 82p) and so offers a diversified, high-quality portfolio of funds at a bargain price.
Turnaround hero Jon Moulton’s Better Capital range of funds used to be popular with those who wanted to make a more focused bet, but disastrous and very public failures at Reader’s Digest and City Link have left the funds trading at a big discount.
But the 2009 vintage of Better Capital (LSE: BCAP) looks interesting. This very focused portfolio seems to be trading solidly – one aerospace investment in particular, Gardner Group, is back on track and growing profits. The pool of investments is now fairly mature and there shouldn’t be any great risk of bad, new acquisitions – we’re into realisation mode. At a 21% discount, the odds of making a decent return are healthier than they were.
Perhaps the safest way in is via HgCapital (LSE: HGT), which focuses on mid-caps in the technology and business services sectors. I’ve long owned the shares – the price hasn’t moved much in the last few years, but recent numbers suggest the UK-based business has recovered its mojo. The total return in 2015’s first half (in terms of net asset value – NAV) was 3.8%, compared to a 3.0% rise in the FTSE All-Share. Ignore the impact of the weak euro and Nordic currencies, and the portfolio’s value actually grew by 12%.
Numis analysts delved into the 20 biggest firms that make up nearly 90% of the portfolio. Most have seen sales and profits grow strongly. HgCapital is also being more aggressive about making new acquisitions. Some investors had feared that the stream of decent-value new businesses was drying up, but the first half has been busy, with £40.5m of investors’ money deployed – including £14.6m into motor and household insurance group A-Plan, and £20.1m into The Foundry, which creates software for use in complex imaging for cinema and computer-aided design. It trades at a discount to NAV of 17%.
…and one for the brave
But if you’re looking for a contrarian bet, check out JZ Capital Partners (LSE: JZCP). This US-based, UK-listed business has traditionally focused on medium-sized private industrial businesses in America. Its NAV has grown for 23 of the last 25 quarters, so it has done a solid job.
But its efforts have been hindered by poor liquidity in the shares (they’re tricky to buy and sell without moving the price), and a complex capital structure, including split cap shares and convertibles. Its US-based managers can also be rather blunt.
But what’s really spooked investors is that the fund has followed many of its bigger peers, such as Blackstone and Carlyle, and diversified into asset management. It has invested in Spruceview/Bright Spruce, which in effect offers outsourced fund management and fiduciary services to endowments and corporate pension funds. The fund has also gone into US housing. As of 30 June, this accounted for nearly 25% of the NAV, comprising 33 houses in Brooklyn and Miami, worth around $250m.
Finally, JZ is setting up a separate fund (with $75m from the listed fund) targeting mid-market buyouts in Europe. It senses big opportunities in the likes of Spain and Italy, where access to bank funding has nearly dried up.
This all takes a lot of new capital. So JZ is raising new funds, even though its shares trade at a huge 39% discount to NAV. And it’s doing it at the share price, rather than the book value price. The issue looks like a done deal. Existing shareholders have subscribed for $135.4m in new shares and those representing more than 50% of share capital are set to vote in favour. This all makes sense from the board’s point of view. It means a lower cost of capital, better underlying liquidity, and debt levels will fall to 33% (based on NAV).
However, many investors aren’t pleased that their holdings will be diluted heavily, and Numis Securities is also less than impressed, saying “JZCP is a fund to avoid” – it should get on with realising value, buy back some shares, and stop shooting off at tangents, such as real estate and investment management.
I take a contrarian view. I think there’s value to be had backing opportunistic managers who are happy investing in relatively unexploited areas, especially US property. Those managers, who include David Zalaznick, are also putting a huge amount of their own money on the line. Wait for the fund raising to go through (and for all those disgruntled investors to sell), allow the new structure to emerge – then tiptoe into the shares.