Impressive results from HgCapital

This week I want to look at another popular investment trust that I've discussed on these pages in the past private-equity outfit HgCapital (LSE: HGT). Hg has been on my core list of funds for quite a few years now, and it announced some impressive results a few months ago.

Selling in a frothy market

The fund's most recent numbers showed strong growth in net asset value (NAV the value of the underlying portfolio), with a total return of 21.5% in NAV terms for 2017, mostly driven by some impressive trade sales. HgCapital's management, rightly in my view, regards the current market as "frothy", and has been busy selling off profitable assets. There were £223.8m of realisations (compared with £135.5m in 2016), versus relatively modest investment of £73.0m in new deals (£104.1m in 2016).

The weighted average enterprise value/Ebitda (earnings before interest, tax, depreciation and amortisation) multiple for the top 20 buyouts was 16.4 times as at 31 December, up from 14.2 times in December 2016. It's also worth noting that the average debt multiple has risen to 5.4 times Ebitda, up from 4.2times at the start of 2017, as a result of a number of refinancings (suggesting these fast-growing businesses are taking on more debt).

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Cash now represents 25% of the fund's net assets, and most analysts expect this to rise as more deals are done. That should serve as a warning HgCapital won't be earning investors much of a return on that cash, although if the management is right, and valuations become a little less frothy in a future sell-off, having a big reserve will be a major positive.

The other noteworthy development is that the managers are pumping an initial £75m into a new internal fund called Hg Saturn. This vehicle is focused on the same space as its most popular existing funds (software, and technology within business services), but looking at much bigger businesses, with a value of roughly £1bn. There are only likely to be four or five investments, rather than a longer list of smaller businesses.

Focusing on bigger buyout businesses makes me a tiny bit nervous, as the competition is much more intense for such deals. However, HgCapital has an excellent track record, so maybe my worries are misplaced. I'm also reassured by an investment in another new fund called Hg Transition Capital, which invests in much smaller technology companies, where the founders are not yet ready to give up control of their businesses through a traditional buyout all of which sounds much more like the trust's sweet spot for deals.

Double-digit growth

Digging into the current portfolio, we see that the vast majority of the big holdings are performing very well. By value, 84% of the portfolio is delivering double-digit earnings growth, including the largest holdings (software providers Visma, IRIS and Sovos), according to investment-trust analysts at brokers Numis. These three companies make up 17.5%, 12.1% and 10.9% of the portfolio respectively.

As of March this year, the portfolio was 76% invested in technology, 20% in services, and the remaining 4% in industrial technology and healthcare. Other interesting companies within its 20 largest investments include Foundry, a developer of computer graphics, visual effects and 3D design software that has worked on film franchises such as Star Wars and Deadpool; and JLA, which provides commercial laundry equipment and dishwashers.

At just over £19 a share, HgCapital trades at a discount of 11% to NAV, towards the higher end of its recent range, while the shares yield 2.4%. I'd still be happy to buy into the fund, though the cash drag is a bit of a concern.

Activist watch

Activist fund ValueAct has built up a $1.2bn stake in bank Citigroup, says The Wall Street Journal. The fund has been buying shares over the past four to five months, and continues to add to its holding "opportunistically" in a bet that the bank's strength as a service provider to corporations will "enable it to thrive in the post-crisis era and make up ground its shares have lost in recent years". In a letter to investors, ValueAct suggested the bank could boost its plan to return cash to shareholders via buybacks and dividends from $40bn to around $50bn, but did not call for significant strategic changes. Unlike activist investors such as Carl Icahn, who publicly agitate for change, ValueAct "considers itself a friendly counsellor to management".

Short positions cash flows out of bonds

Fund manager Baillie Gifford is planning a "root-and-branch overhaul" of the £307m Schroder UK Growth portfolio, says Daniel Grote on Citywire's Investment Trust Insider website. Baillie Gifford is expected to take over the running of the "ailing" UK All Companies investment trust in the next six weeks, and its managers plan to sell all but "a handful" of stocks from the current portfolio, as they move it to a growth-focused, high-conviction approach, says Grote. The current portfolio features a heavy weighting to traditional value stocks such as banks and oil companies, with Shell, BP, Standard Chartered and Lloyds all featuring in the top ten. Over the past five years, the trust's shares are up just 42%, half the 82% of the average trust in the UK All Companies sector. Shares were trading at a discount of roughly 13% to net asset value, but the news of Schroders' sacking as manager and its replacement with Baillie Gifford has narrowed this to under 10%.

In Europe, more than half of the 20 funds that saw the biggest outflows of investor cash in the first three months of the year were fixed-income funds, according to data from Morningstar, says Owen Walker in the Financial Times. The list includes Amundi's €10.7bn 6 M Fund, with €874m in outflows, and Jupiter's €9.5bn Dynamic Bond Fund, with €1.3bn in outflows. US high-yield and European corporate-bond funds were hardest hit, losing €7.5bn and €5.3bn respectively. In the US, of the 20 funds with the biggest outflows for the first quarter, nine were bond funds, while several others also invested in fixed-income assets.