The private equity puzzle

Private equity has grown rapidly in recent years. By 2024, there were more than $6 trillion in private equity assets, up from $2 trillion a decade ago, according to data firm Preqin. Venture capital added about $2 trillion more, up from $0.5 trillion in 2014.

While that sounds huge, it is still a fraction of the size of public markets. Total private equity and venture capital investments – including funds of funds – are roughly 12% of the size of public equity markets, according to private equity group HarbourVest, even though there are nearly 25 times more privately backed companies than public ones.

Returns have been solid. In the 25 years to the end of 2024, private equity funds returned about 9% a year, with volatility of around 10%, according to Deutsche Numis and Datastream. UK government bonds returned 4% a year over the period, with volatility of roughly 6%, while the FTSE All-Share returned 5% a year, with volatility of about 15%.

Still, past performance is not a reliable guide to the future, and there are reasons to think private equity’s long boom could be ending. Higher interest rates increase the cost of the debt that plays an integral role in financing leveraged buyouts.

Meanwhile, weak appetite for private equity-backed initial public offerings (IPOs) mean that managers are struggling to offload mature holdings they own onto public markets – of course, this indigestion is partly because many private-equity IPOs have subsequently performed poorly.

Unjustified discounts in private equity

However, investors shouldn’t write off the sector just yet. Listed private equity trusts in the UK offer exposure to industries and portfolios of companies not available on the London Stock Exchange. For example, HG Capital (LSE: HGT) owns a portfolio of tech businesses, a sector poorly represented in the UK market.

The majority of the sector is also trading at a deep discount to net asset value (NAV), despite evidence to suggest discounts are conservative, on average. Private equity trusts rely on in-house processes to put a value on their portfolios. The results are highly subjective, and so valuations are only proven when assets are sold. However, last year all the main trusts sold assets at a premium to their carrying values.

In the case of HarbourVest Global Private Equity (LSE: HVPE), the premium was roughly 30%, compared with the trust’s current discount to NAV of 33%. HG Capital’s average premium was around 15%, against a current discount of 8%. Pantheon International (LSE: PIN) achieved close to 25%, despite a discount of 33%. Over the five years, the average uplift on exits was about 30%. HarbourVest was an outlier, with an average of nearly 80%.

Playing the whole private equity sector

As an alternative to individual trusts, funds such as iShares Listed Private Equity (LSE: IPRV) and Pareturn Barwon Listed Private Equity Fund hold a diversified portfolio of trusts and listed managers.

“Although trusts and managers are fundamentally different, we think they’re highly complementary and allow an investor to gain exposure to ‘both sides of the equation’ – ie, the returns on the investments, and both the management and performance fees the manager earns on its investments,” says Bob Liu of Barwon. This also provides diversified exposure to managers who are increasingly focused on specific regions, sectors or market segments.

However you approach it, bulls argue the market is undervaluing private-equity assets, which will be bought up if discounts do not close. As if to prove this point, the Goldman Sachs-controlled, London-listed Petershill Partners (LSE: PHLL) – which provides growth capital to private equity and managers – announced two weeks ago that it is going private. The buy-out offer is a solid 35% premium to its pre-announcement price.

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