Two robust trusts for the long term

Gain exposure to private equity and emerging-markets infrastructure in your regular savings plan.

I’m currently putting together a robust, slightly alternative portfolio of investment trusts where I believe your capital will be well looked after over the long run. Two weeks ago, I picked my first – TR Property (LSE: TRY). This week I have two more: HgCapital (LSE: HGT) and Utilico Emerging Markets (LSE: UEM). Both are widely respected specialists with exposure to very divergent themes: HgCapital for private equity and Utilico for emerging-markets infrastructure (which I’ve discussed here before, so won’t spend quite as much time on this).

Investing in private equity

In any diversified long-term portfolio, I think you should have exposure to smaller companies and, crucially, private businesses. I expect both to trounce publicly listed mega-caps over the next few decades. In fact, I struggle to understand why so many growth-orientated businesses choose to list at all. After suffering the publicity, hassle and short-termism of keeping public shareholders happy, many companies end up going private again.

This life cycle of enthusiastically listing, despairing at the realities of public life, then “going private”, causes many business owners to think twice about going public in the first place – especially if they can get the right private-equity manager to underwrite their growth plans. This is where the likes of HgCapital come in.

Most private investors’ view of private equity goes something like this: take a big, boring, public business. Buy it, lard it up with plenty of debt, then flog it to another private-equity schmuck who is paid an obscene amount of money based on a tax-efficient “carried interest” model. There is some truth to this debt-addled, tax-minimised model – but the likes of HgCapital are different.

It uses debt, of course, and I’m sure its key principals are more than adequately remunerated, but its focus is on growth-orientated businesses where it can add real value through operational expertise and perhaps combining two companies into something bigger. HgCapital has quietly built a reputation in the City as a rather fussy private-equity house that focuses on mid-sized European quality growth companies, which provide a business-critical product or service, boast highly predictable earnings from contracted or recurring revenues, and have a diverse, loyal customer base.

A solid margin of safety

Its long-term record is excellent. Its net asset value (NAV) has grown by 11.2% a year over the past decade, versus 5.6% for the FTSE All Share index. In 2015 it made a NAV total return of 14.1%, versus a 1% rise in the FTSE All Share. The second half was particularly strong, reports Numis. NAV growth of 9.8% was driven by healthy trading from its major investments, reflected in revenue growth of 10% and earnings growth of 12% for the top 20 buyouts.

Some of the profit was offset by adverse currency movements (-£10.2m) and a provision for one of the funds. But there were compensations – a 40p dividend will be paid in May 2016, up 25%, which is the equivalent of a yield of 3.3% based on the current share price. The fund has been criticised for being too niche, with inadequate deal flow, but already this year it has announced four new investments worth a total of £48m, and realisations of £59m.

It hasn’t used up all its firepower though – it’s sitting on cash of £42m, equivalent to 8% of net assets, plus an undrawn debt facility of £40m, which has been extended to mid-2019. That should come in handy – I expect to see a long line of private businesses out there, unnerved by volatile public markets, looking for the right institutional investor.

I also think that now is a good time to invest. The share price is around £11 – a 25% discount to the NAV of 1,455p per share (as of 29 February). That’s a good margin of safety for an investment trust with a long track record of beating the market.

Infrastructure in emerging markets

As for Utilico Emerging Markets – the fund is led by Charles Jillings of ICM Ltd. It invests in publicly listed businesses that provide infrastructure services in emerging markets: utilities (power, water/waste, gas); infrastructure (airports, ports, toll roads); and communications (fixed line, mobile, satellite). Utilico takes a bottom-up investment approach, with an emphasis on understanding the business niche, rather than focusing on valuation. NAV total returns have come in at 8.8% a year over the last ten years, versus 7.3% from the MSCI Emerging Markets index.

It’s not for the faint of heart, but the yield is currently 3.6% and the discount around 10% – wider than the average over the last ten years. The portfolio is concentrated (thus risky). The top ten positions account for 53% of assets: gas (15.6%), ports (15.5%) and electricity (13.1%) are top sectors. China & HK (29.5%), Malaysia (16.6%), Brazil (10.4%) and the Philippines (8.1%) dominate.

Investment trust Share price (7/3/16) Discount Yield
HgCapital (HGT) 1,081p 25.7% 3.3%
Utilico EM (UEM) 176.5p 10.2% 3.6%