As Byzantine intrigue makes the political outlook for the UK ever more uncertain, investors continue to pull money out of equities. In July, equity funds saw the highest level of net outflows from retail investors (£1.7bn) for three years, including £1.2bn from UK funds and £400m from Europe.
Meanwhile, the better fund managers are just focusing on securing high returns whatever the challenges. Few have been more successful this year than HG Capital Trust (LSE: HGT), the listed technology-focused private equity fund with a market value approaching £1bn.
The trust is the largest single investor in the £10bn of funds managed by HG, while HG’s investments in software, which boast a combined turnover of £4bn, make it the third-largest and one of the fastest-growing technology businesses in Europe.
A powerful portfolio
This growth continued in the first half of the year with the net asset value (NAV, the value of the underlying portfolio) increasing by 14% to 242p per share. Profit growth in the underlying assets accounted for two-thirds of the uplift with one third attributable to an increase in valuation from 17.3 to 19.5 EV/Ebitda (equity valuation plus debt divided by earnings before tax, depreciation and amortisation).
This valuation “appears high relative to history as well as to its peers”, says Charles Cade of Numis Securities, “and there is a threat that multiples could fall if there is a setback to equity markets”. However, growth in the underlying businesses continues at a strong pace. Based on the top 20 investments, accounting for 88% of the portfolio, sales growth in the last 12 months was 26% and cash earnings rose 35% on margins of 28%. At such a rate of growth, the rating on prospective rather than historic cash earnings would have been in the mid-teens. Far from slowing, this growth is actually accelerating. This year it should easily exceed the compound growth in NAV over ten years of “only” 14%.
The secrets of its success
How does HGT do it? The largest investments, in Cade’s words, “have little sensitivity to economic growth, reflecting a focus on fast growing, cash generative businesses with a high proportion of recurring earnings”. Private equity is a highly competitive business but HG boasts of “one of the largest dedicated tech teams in Europe with over 90 executives and operators”.
This enables them to find potential investments which are not being marketed, to identify additional business opportunities for them, to manage them more rigorously and to achieve high-value exits. HG is not a passive investor but actively seeking to get the most out of the companies, both operationally and strategically. This includes being “highly focused on making further accretive bolt-on acquisitions into our portfolio companies”, says HG. There have been 34 of these in 2019 by eight portfolio companies.
Disposals in 2017 and 2018 at £500m were nearly twice the capital invested. The largest of these was at an impressive 80% uplift to book value, twice the average of the 11 disposals in the last 18 months. This strongly suggests that there is plenty more upside to the asset value as disposals continue and so the 5% discount to NAV at which the shares trade is much better value than it first appears.
But what about Brexit? As Cade points out, 30% of the portfolio by value at June 2019 was headquartered in the UK; but few of HG’s investments trade between the UK and the EU, and none participate in physical deliveries. In addition, HG indicates that it cannot “identify any specific adverse effects of a separation in the regulatory frameworks to which any business is exposed”.