It makes sense to incorporate private companies into your overall asset allocation. As discussed previously, private markets have a solid historic record of outperforming public ones over the long run and offer an array of diversification benefits.
But what is the best way to gain access to these markets? Many investors already have at least some exposure to private companies in their portfolio. This may be via popular investment trusts which have some investments in specific unlisted companies alongside their holdings of larger public firms, or through trusts which invest directly in private companies. Others may have invested through venture capital trusts which focus on building portfolios of youthful companies, or perhaps even own shares in private companies directly through crowdfunding, for example.
All of these options have their appeal. However, they largely offer targeted exposure only to specific segments of private markets. Those who wish to add a broad, diversified allocation to private companies to their core portfolio might want to consider a listed private equity fund-of-funds as an alternative or an addition to the above.
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What benefits can a fund of funds offer over these methods? Diversification is a major benefit. Investors typically think of diversification as being by industry or geography, and these of course are important. But when it comes to private companies, there is a further vital aspect to diversification, which is company maturity.
While funds investing in publicly-listed companies can conceivably adopt a “buy and hold forever” strategy, those investing in private companies must always have an eye on the “exit” – the point at which they crystallise the value of the company and move into the next investment. As a result, a well-balanced portfolio of private companies will not only contain a range of business sectors, but also companies at different stages of growth; investments at different stages of maturity (from early-stage investments to those which are almost ready to be sold); and across a range of strategies, from venture investments to management buyouts of more mature companies.
This diversification across time as well as the investment landscape would be impossible for an individual investor to recreate in their own portfolio. The barriers to entry are significant. To gain direct access to most private equity funds requires a minimum investment of upwards of £1m and frequently tens of millions. Building and managing a sensibly diversified portfolio of such companies requires the ability to access ongoing sources of new investment opportunities; active and sometimes intense engagement with companies within the portfolio; plus the management and timing of successful exits. A listed private equity fund-of-funds offers exposure not just to a fully invested portfolio of private companies, but to an entire investment and exit process which would be otherwise virtually inaccessible to private investors, all without prohibitive minimum investment requirements.
On top of that, on the valuation side, listed private equity funds-of-funds can also offer perhaps surprisingly good value. They tend to trade at discounts to the underlying value of their portfolios (the net asset value, or NAV). In effect, when you invest, you are getting the underlying portfolio for less than it’s worth. This is not unusual for investment trusts. However, private equity funds-of-funds have tended to trade at even more significant and more persistent discounts than the wider sector. This is partly due to a perception of the listed private equity sector as both expensive and complicated.
Given the ongoing consistent growth in the value of the underlying portfolios and the overall performance of private companies in general, this tendency towards big discounts seems hard to justify. That’s even more the case when you consider that in the case of private markets, this discount will often be even larger than it appears. This is because the valuation of private companies is only updated at the end of a reporting period (typically quarterly) rather than on a daily or minute-to-minute basis as with a listed company. As a result, the most recent “paper” valuations may well lag behind the “true” value of the portfolio, meaning that the actual discount to NAV is even greater than is apparent.
In short, a high-quality listed private equity fund-of-funds gives investors straightforward access to one of the few areas in today’s investment world where genuinely active management can pay off in the form of better returns – and it can often be bought for less than its “true” value.
Richard Hickman is director of investment and operations at HarbourVest Global Private Equity Limited. For more information visit www.hvpe.com
Disclaimer:
This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such.
Certain information contained herein constitutes forward-looking statements, which can be identified by the use of terms such as“may”, “will”, “should”, “expect”, “anticipate”, “project”, “estimate”, “intend”, “continue”, or “believe” (or the negatives thereof) or other variations thereof. Due to various risks and uncertainties, including those discussed above, actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. As a result, investors should not rely on such forward-looking statements in making their investment decisions.
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