The private-equity sector has seen contrasting fortunes in the last five years. While 3i has quadrupled its investors’ money, investors in Candover have lost nearly two-thirds of their investment. Both were brought to their knees by the financial crisis, but while one bounced back, the other went on falling.
By contrast, the listed “fund of funds” private-equity vehicles have had a much narrower spread of returns. However, they provide less visibility on their underlying investments, which makes them less popular with investors. All but one trade at double-digit discounts to net asset value (NAV – the value of the underlying portfolio). However, discounts have been falling, which is why the average investor’s return on these funds (148% over the last five years) is well ahead of the underlying portfolio performance of 83%.
This looks good against the 60% return of the UK market, but less so compared with the 100% return on global equities. If these funds are to keep shareholders happy, they need to improve underlying returns, continue to narrow their discounts, or both. Pantheon International (LSE: PIN) is addressing the issue with a reorganisation intended to kill several birds with one stone. It is merging its two share classes into one, with a market value of £1.2bn, greatly improving liquidity (ease of buying and selling). Meanwhile, it is hiving off most of its older investments into a separate fund, so that 8% of the portfolio, rather than 18%, dates from 2006 or earlier.
Funds less than ten years old outperform older funds by 2.9% a year, reckons Pantheon. But new funds also tend to underperform, because it takes time for them to be fully invested and for the businesses acquired to build up momentum. So Pantheon has been shifting its focus away from “primary” commitments to “secondaries” (commitments acquired secondhand from other investors) and to direct co-investments made alongside funds in which Pantheon invests. Secondaries and co-investments now account for two thirds of new commitments.
All of this suggests that underlying performance (up 89% in the last five years) should pick up, and that the discount (currently 18%) should continue to narrow. Failing that, the cash generated by the underlying portfolio will enable Pantheon to add value by buying back its own shares cheaply.
Compelling as this looks, Pantheon will struggle to catch up with the blistering performance of Harbourvest Global Private Equity (LSE: HVPE), which trades on a discount of more than 20%, despite an investment return nearly 30% ahead of Pantheon in the last five years. Like Pantheon (but unlike the broader private-equity sector), Harbourvest has the majority of its assets in the US. Its market value of nearly £1bn makes the shares liquid.
Why are investors looking such a gift-horse in the mouth? While the five-year performance of private equity relative to global indices is not particularly compelling, returns over ten and 20 years have been nearly double those of listed equities, notes Harbourvest. Perhaps a period of strong performance from listed equities has led investors to forget the longer-term record, or perhaps they are fixated on the difficulties some funds encountered in the financial crisis. Yet at today’s valuations, Pantheon, and Harbourvest especially, are bargains.
Swiss chemicals company Clariant is “playing with fire” in dismissing demands from US activists to hire new advisers for a strategic review of its business, says Chris Hughes on Bloomberg Gadfly. White Tale Holdings, which owns 20% of the company, wants Clariant to use an investment bank with no existing commercial ties to the company to carry out a review. It argues that Clariant didn’t consider all of its options when it agreed to merge with Huntsman Corp, in a deal that was later “torpedoed” by the activists. However, the chemicals company thinks White Tale’s push for it to switch advisers is motivated by a desire for it to find a body that will recommend breaking up the company.
In the news this week…
• Norway’s $1trn sovereign wealth fund “meant business” when it said it wanted companies to curb “excessive and opaque top-management pay”, says Mikael Holter on Bloomberg. Since releasing a paper on the subject in April, it has increased the number of “no” votes it makes on remuneration packages (exact figures aren’t available). But the fund “risks throwing its weight around in a way that exceeds its authority, intervening in the sovereignty of other nations”, reckons Mark Gilbert on Bloomberg Gadfly. Its “sheer size – it owns about 1.5% of every listed company in the world… gives it clout. But its status as an arm of the government of Norway should make it wary of behaving like just another custodian of assets.”
• “Alt-beta” strategies, a close relation of smart-beta, are disrupting the already-struggling hedge-fund industry, says Owen Walker in the Financial Times. A growing number of alternative-beta products have flooded the market in recent years. These are investment vehicles that seek to automate many of the processes carried out by hedge funds, such as shorting, whereby managers aim to profit by betting that a company’s share price will fall. Global assets managed by alt-beta funds have increased from $2bn in 2010 to around $94bn at the end of June this year, as investors choose this cheaper alternative to traditional hedge funds.