Advertisement

Buy these two funds to profit from private companies

Don’t be put off by Neil Woodford’s disaster. These two funds have done well with unlisted firms.

Tesla Model 3 plug-in electric car © iStockphotos
Large-cap listed firms such as Tesla have disappointed Scottish Mortgage

The Woodford affair and the plunging share price of the Patient Capital Trust have been stark reminders that private companies can be highly risky and very illiquid.

But recent results from Scottish Mortgage Investment Trust (LSE: SMT), the global equities investment trust run by Baillie Gifford, reminds us that investing in private companies can be lucrative if done in the right vehicle and with a sensible long-term strategy.

Advertisement - Article continues below

Over the six months to 30 September, SMT suffered from underwhelming returns, with the net asset value (NAV) rising by just 3.2% compared with an increase of just under 10% for the FTSE All World index. But since 30 September, the fund's NAV is up 2.8% versus 0.5% for the benchmark.

Finding the right private companies

According to Numis, between the fund's first unquoted investment on 2 June 2010 and 30 September 2019, the return of all stocks initially owned in unquoted form (whether now listed or not) has been 445.3% versus 341.4% for Scottish Mortgage overall, and 183.8% for the FTSE All-World.

Advertisement
Advertisement - Article continues below

Crucially, the fund invests in private companies that are established, often highly cash-generative companies, typically with valuations well over $1bn.

There is an important trend at work here that helps explain SMT's approach. Many of the best businesses globally are choosing to stay private longer.

Equity analysts at Morgan Stanley (MS) also point out that private equity can use incredibly cheap debt to fund growth. The weighted-average cost of capital is near all-time lows; the cost of equity in Europe is around 6% to 7%, while the European credit yield is under 2%.

Stockmarkets out of fashion

Private equity, by contrast, the report suggests, "is able to take a long-term view". It is willing to finance large capital expenditures, even if these crimp profits at first, and do deals where there is significant short-term political risk.

Advertisement - Article continues below

The real-world effects of this changing culture are clear. Overall mergers and acquisitions activity across Europe is plunging but the share of private equity transactions has rocketed.

Flotations are down substantially as more and more of these private businesses stay private. Eighty-four companies have listed in Europe this year, the fewest in a decade. And among the dwindling band of firms that do list, market-cap size is declining.

So growth businesses are choosing to stay private longer and avoid initial public offerings (IPOs). Many are also choosing to take extra growth capital from both private equity investors and outfits such as Baillie Gifford.

Add it all up and you can see why private equity funds such as HgCapital (LSE: HGT)are prospering. The fund's NAV is up 2.2% since 31 August, while NAV gains since 30 June have totalled 3.9%, driven by strong sales and earnings before interest, taxes, depreciation and amortisation (Ebitda) growth from the businesses in their portfolio. HGT's share price is up 39% so far this year. The Woodford Patient Capital affair is a wake-up call but private businesses are worth investing in the trick is to work out how to build exposure to the right kind of private businesses, using the right kind of fund.

Advertisement
Advertisement

Recommended

If you think now is a good time to buy, look at these investment trusts
Investment trusts

If you think now is a good time to buy, look at these investment trusts

With the latest market slides, an awful lot of assets are beginning to look very cheap indeed. If you are thinking of buying, Merryn Somerset Webb has…
10 Mar 2020
How to build a properly diversified investment trust portfolio
Sponsored

How to build a properly diversified investment trust portfolio

Max King explains how to build a well diversified portfolio using one of our favourite tools – investment trusts.
25 Feb 2020
Why investment trusts are the best vehicle for your money
Sponsored

Why investment trusts are the best vehicle for your money

Max King explains the advantages of investment trusts – sometimes called closed-ended funds – over their open-ended counterparts (or Oeics).
11 Feb 2020
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020

Most Popular

BP has slashed its dividend – and markets love it
Income investing

BP has slashed its dividend – and markets love it

BP has bowed to the inevitable and cut its dividend in half – and its share price promptly rose. John Stepek explains what it means for shareholders …
4 Aug 2020
Listed companies are dying out, and that could have serious consequences
Stockmarkets

Listed companies are dying out, and that could have serious consequences

Private equity is taking over from public stockmarkets as the biggest provider of capital to companies. That’s bad for investors and bad for society a…
3 Aug 2020
Can the recent rally in sterling continue?
Sponsored

Can the recent rally in sterling continue?

A "double top"  – a very recognisable pattern – is forming in in the US dollar. Dominic Frisby explains what it is, and what it could tell us about st…
3 Aug 2020