I’ve always had a bit of soft spot for private equity investment trusts. One of the first trusts I bought was F&C Enterprise (now ICG Enterprise) back in the 1990s. I’ve held HgCapital for nearly a decade now and Princess Private Equity joined my portfolio in 2018.
Does private equity outperform?
Let’s say the evidence is mixed, both for the overall asset class and for private equity investment trusts.
There are a few studies suggesting private equity returns tend to be higher than listed equities. And that’s even adjusting for the higher fees that they tend to incur.
This could be due to the higher level of debt their investments usually carry. Or because private equity firms are particularly good at improving business with their hands-on management style.
Others think that there is a little creativity going on with the performance numbers, as the likes of Warren Buffett pointed out recently. Or that most of the past success has come from the ability to buy at low multiples and sell at much higher ones.
Certainly, if you make a crude comparison of the average private equity investment trust against the average investment trust then private equity has lagged significantly this past decade (206% vs 274% in net asset value terms) although it’s outperformed over the last five years (93% vs 74%).
Those are the figures excluding 3i, as its sheer size distorts the averages for this sector. It’s the largest private equity investment trust by absolute miles, accounting for 47% of the sector’s £18.6bn of assets.
It’s worth noting that 3i trades at a massive premium of 45%. The other 18 private equity investment trusts have an average discount of 15%, and only three of them have a discount of less than 10%.
And be aware that when private equity does go wrong, it really goes wrong. Better Capital 2012 has returned -66% over the last five years while LMS Capital has returned -11% over the last decade!
Too much Hg
When it comes to my own private equity investments, I have to admit I did get a little carried away with HgCapital. It did well for me and I kept adding to my holding.
By the end of 2017, my position size was making me a little uncomfortable and it was trading at a pretty small discount compared to most other private equity trusts.
I searched around for an alternative to balance the load a little and ended up investing in Princess Private Equity. And I added a little more Princess earlier this year.
A little history
Princess is run by Partners Group, a Swiss-based private firm that has over $80bn of assets under management. Princess is a pretty small part of its overall operations, accounting for just 1% of its assets under management.
Partners is one of the larger private equity firms. The latest industry ranking, PEI 300, puts it an #21 with $15bn raised over the last five years. The largest firm, Blackstone, raised a whopping $83bn.
The history of Princess is a little unusual. It was originally funded by convertible bonds. These were converted into shares in 2006 and then the company was listed in Frankfurt. It joined the London Stock Exchange in November 2007 and delisted from Frankfurt in 2012.
Here are some basic numbers for Princess:
- Founded: 1999 (listed in the UK in 2007)
- Manager: Partners Group
- Ticker: PEY (euro) and PEYS (sterling)
- 10-year net asset return: +160%
- Current price: 877p
- Indicated spread: 864p-890p (3.0%)
- Exchange market size: 750
- Results released: Feb, May, Aug, Nov
- Market cap: £675m
- Discount to net assets: 14%
- Costs: 3.2% OCF and 4.1% KID
- Gearing: 2%
- Historical dividend and yield: 0.57 euros (about 51p) and 5.8%
- Dividends paid: Jun and Dec
- Style: Private equity, diversified both by sector and geography
- Links: Website and AIC page
Although the indicated spread is quite wide for the sterling-quoted shares, I was able to get well inside it both times I purchased Princess. Perhaps I just got lucky. The euro-quoted shares do seem to have a smaller spread.
Deep, deep discounts
The global financial crisis resulted in a bit of baptism of fire as far as its reputation with UK investors goes. Princess went to a massive discount to its net asset value as the financial world began to crumble.
This chart shows the aftermath of the carnage and the recovery since:
The discount ten years ago was an incredible 68%, and I suspect it was even greater earlier in 2009.
Princess wasn’t the only private equity trust that had deep discounts issues like this, but it’s a sobering reminder of how bad things can get when the financial markets turn against you.
Private equity funds were particularly affected because it was feared the high level of debt many of their investments carried would turn out to be fatal.
Princess originally invested in other private equity funds but in 2010 decided to shift its focus, albeit gradually, to direct investments into individual companies.
Indeed, you can usually split private equity funds into either direct or fund investors. The likes of HarbourVest, Pantheon, and ICG tend to invest in private equity funds, whereas 3i, Apax, HG, and Princess invest directly into unquoted companies.
Direct investors tend to have more concentrated portfolios and sometimes specialise in a few sectors. As a very general rule, they tend to be riskier but offer greater returns (and a greater range of returns).
The move to direct investment seemed to please Princess’s investors, though, with the discount narrowing from 50% to 25% in less than a year after it was announced.
The discount almost disappeared over the course of late 2016 and 2017, helped by the introduction of the sterling-based ticker in September 2017.
Since then, though, the discount has widened again, despite Princess’s net asset value making steady progress in 2018 when global markets fell.
One unusual feature of Princess is its distribution policy of paying out 5-8% of opening net asset value each year. From what I can tell, it’s typically nearer the bottom end of this range.
Note that it’s a target rather than a fixed commitment. 30 euro cents was paid out in respect of 2007 and 2008 but nothing was paid for 2009 or 2010.
The dividend made a comeback for 2011 but at a much higher level of 45 euro cents. However, the dividend remained at 54 euro cents for 2014, 2015 and 2016, increasing only slightly to 56 for both 2017 and 2018.
The first-half payment for 2019 was 29 euro cents, so it looks like investors should get 58 euro cents in total for this year, which is 5.3% of the opening net asset value.
20 years of returns
The Princess website is pretty informative and the company regularly publishes a version of this chart showing its return against world markets since it was founded.
The first ten years of the fund delivered a zero per cent return, but that still beat world markets by a handsome margin!
This gap actually narrowed as the transition to direct investments took place, but it’s been re-established these past five years with Princess ahead of world markets by an average of 3.2% a year.
Princess’s charges are pretty high, in common with most private equity firms. The base management fee is 1.5%, with a 15% performance fee on returns over 8% a year.
As usual, there is a significantly different cost number depending whether you look at the quoted ongoing cost figure or the number on the Key Information Document.
Part of the difference is likely to be the underlying cost of the private equity funds Princess invests in but I suspect the majority relates to transaction costs.
Princess has a pretty decent spread of investments and typically aims to have between 50 and 80 direct holdings.
Its two largest, Action and Permotio, both weigh in 8.7%, but its third-largest is 4.5%. In total, 14 investments account for 2% of assets or more.
Right now, its direct investments account for 90% of assets. The legacy fund holdings make up the other 10% and this number seems to be reducing by a few per cent each year.
Of its direct investments, about 63% are where Partners Group was either the lead or co-lead investor. 15% are other co-investments it did not lead and 12% are debt.
Mid-market deals, typically between £500m and £2bn are its sweet spot, with 60% of its assets falling into this category. Only 11% is represented by large deals above the £2bn mark, with special situations being some 12% and early-stage investments about the same.
Sector-wise, three industries dominate, namely consumer discretionary (32%), IT (15%), and Healthcare (13%). There’s very little exposure to telecoms, energy, or utilities (these account for just 8% combined).
The geographic spread is mostly developed markets with Europe at 51% and North America at 34%.
Doing it with style
The paid research firm, Edison, has produced a few reports on the company in the past eighteen months which are worth reading for more background information on Princess’s investment style.
Here’s a snippet:
In an environment of generally high prices for private equity deals, Partners Group hasfound it beneficial to focus on companies that fit into one or more of the following categories:
- Platform companies: well-managed businesses that can be expanded via bolt-on acquisitions;
- Category winners: companies with a strong competitive position in a growing market segment;
- Defensive leaders: cash-generative businesses in market areas with high barriers to entry.
A fundamental part of the Partners Group private equity investment approach is its industry value creation (IVC) team, which it uses to help drive through initiatives to enable companies to strengthen their financial and competitive positions, and achieve their full potential.
It’s difficult to say how much of a differentiator the IVC team is, but it does suggest a very hands-on approach.
In terms of investment commitments, there doesn’t seem to be any particular issue right now. Commitments total 79m euros, of which 29m euros relate to the legacy funds although Princess thinks these are unlikely to be called in full.
Princess has access to a 50m euro revolving credit facility to help out if needed. It was undrawn at the end of March 2019.
Net buyer or net seller?
One useful thing to look at with private equity trusts is the balance of sales and investments over time.
The multiples paid for private businesses have been rising these past few years. And there are frequent stories about the amount of ‘dry powder’, that private equity money on the sidelines waiting to be invested. Indeed, some estimates put the amount of dry powder at a frighteningly high $2 trillion.
Given these trends, I’d be somewhat wary of any private equity trust that was a big net investor right now.
Here’s the profile of Princess’s investments this past decade. Its invested steadily for the most part and generally been a new seller in most quarterly periods.
Although 2018 saw net cash outflows in two quarters, Princess reckons the remainder of 2019 will be quieter due to high valuations.
Reassuringly, it also said that “given current elevated entry valuations, Partners Group prudently assumes multiple contraction in the underwriting for a large majority of investment opportunities over the holding period.”
Not having held this trust for that long, I’m still seeing how it progresses. Despite the new-ish sterling quote, it seems to have a pretty low profile among UK investors. I suspect it will be more of a plodder than HgCapital, but it seems a slightly less risky play.
Princess’s share price does seem to jump about a fair amount for no obvious reason. Its net asset value is updated monthly and has crept up steadily for some time now. Despite this, its share price has wobbled around between £8 and £9 a number of times this year.
I don’t mind a bit of volatility, though, as it can often help you build up a position over time. If another such opportunity presents itself, I might be tempted to have a further nibble.
Note that I may own some of the investments mentioned in this article. You can see my current holdings on my portfolio page. Nothing in this article should be regarded as a buy or sell recommendation as this site is not authorised to give financial advice and I'm just a person writing a blog. Always do your own research!
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