Literacy Capital: Great returns fund a good cause

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The scale of private-equity firms has driven them to pursue larger and larger deals. And conditions for these have been getting tougher.

“Across the market, exits are difficult, with many funds full of over-valued assets,” says veteran private-equity investor Jon Moulton. There have been few flotations and listed companies are prioritising share buybacks rather than acquisitions. That leaves other private-equity funds or continuation funds – a fund set up to buy assets from existing funds run by the same firm – as almost the only buyers. Hence returns from large buy-outs have fallen to 10%-12% and investors need to be patient.

By contrast, Moulton – who now invests through his private office to fund medical research – is in a different part of the market. His 40-strong portfolio is invested in deals ranging from “a few hundred thousand pounds to three million at cost”.

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It is difficult for most private investors to get exposure to similar opportunities. Wealthy individuals can get access to investment networks, specialist funds or venture capital trusts (VCTs). But these options have high minimum investments, high costs and low liquidity – and recent returns from VCTs (the most visible part of the market) have been poor.

Literacy Capital is offering a surprising discount

However, there is one listed fund investing solely in smaller UK companies. Literacy Capital (LSE: BOOK) was launched in 2017 by Paul Pindar, the former chief executive of Capita, and his son Richard. It was listed in 2021 and now has £312 million of assets. Each year, the trust donates 0.5% of net assets to literacy and education charities – hence the name.

There is plenty more to like about the trust. More than half the shares are owned by the directors (including the Pindars) and the managers. There is no carried interest or performance fees: the management team – other than the Pindars – has the incentive of nearly 600,000 warrants. The annual management fee of 1.5% is relatively low (private equity is very labour-intensive).

The shares have returned 420% since inception in 2017. Yet they now trade at a 27% discount to net asset value (NAV) after a 20% share-price decline over the past year. This is largely a result of recent dull investment performance, with a NAV gain of 2.6% in the 12 months to end September. Nonetheless, sales still grew at 4% for the top-10 holdings, with 9% growth in cash flow. Debt is moderate and holdings are valued at a modest average of 9.5 times cash flow.

Literacy takes both majority or minority stakes in UK businesses that are generating between £1 million and £10 million of cash flow. Typically, these are companies whose founders want to de-risk by releasing equity, some shareholders want to exit, families want to plan for management succession, or where non-core businesses are for sale. Literacy adds value by strengthening management from its connections (more than 45 executives appointed), assisting with bolt-on deals (more than 40 completed) and providing advice.

Literacy Capital's long-term focus

There are 20 positions in the portfolio, with 83% invested in the top 10. The largest holding is RCI Group, a specialist provider of healthcare to the police, custodial and judicial services. It accounts for 30%.

Two new investments and a partial realisation this year have left the portfolio fully invested. “We see multiple new opportunities each day,” says Richard Pindar, but Literacy is in no hurry to sell, and its fee structure is intended to promote a focus on the long term. “Carried interest can encourage managers to sell prematurely.” So the absence of short-term news shouldn’t put investors off – it creates the opportunity for valuation gains and a narrowing of the discount in due course.

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Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.