One of the characteristics of the most recent growth phase in the UK stock market was a belief that the biggest profits were being made by the venture capitalists, those well-heeled City financiers who bought out a company, took it private, loaded it up with debt and proceeded to strip out its assets and make considerable amounts of money in the process.

This image is, however, a long way from reality. John Moore, head of the collective investments service at Brewin Dolphin, argues that ‘There is a lot of misinformation about private equity, which has put private investors off.

They think that private equity investors leverage everything up to the hilt, which, admittedly, is what the US operators like KKR and Blackstone do. But that is not really the approach of the UK-based private equity managers, who are more interested in bolt-on investments where they can build up the value over time.

‘You have got to look at private equity investment as a seven-year project. If you look at Electra as an example, in 2000 they bought a lot of good companies, although this didn’t start showing through for two or three years.’

Alternative approaches
There are two main types of private equity investment trust: those that invest directly in private businesses, and funds of funds investing in other private equity funds. There are also hybrid versions that combine these two approaches.

Ian Armitage, a partner at Hg Capital, feels that ‘You can’t say that investing in listed private equity funds is better than traditional private equity or vice versa; they are just different methods of access. But funds of funds make sense for private investors, because the fund’s managers tend to get into the better funds. And the difference between top-quartile managers and third-quartile managers in the private equity arena is stark. Private equity managers are much more consistent than managers of portfolios of public companies; the reasons for this are culture and compensation. Fund managers tend to say they like the culture and they only get paid after there has been a return to investors. So even if there is a downturn, we think these funds will continue to do well.’

It is also important to remember that there is an international dimension to private equity investment, with an increasing number of UK-listed funds also having exposure to private equity holdings in overseas markets.

Armitage points out that ‘Investors should also appreciate the global reach of these portfolios. There are around 3,000 private equity managers around the globe. Through a fund of funds, you could invest in many of these, including those that aren’t public vehicles but which do have funds to invest in. Private equity may, indeed, be a better way into, say, Asia than public equity, as you don’t have the liquidity problems and you do have more control.’

Spreading the word
Indeed, iPEIT, an umbrella body of private equity investment trusts, recently gained its first European member, the Swiss-based Partners Group, which runs two UK-listed private equity investment vehicles. Urs Wietlisbach, executive vice-chairman of Partners Group, observed, ‘We are pleased to join iPEIT and thereby assist in further raising the awareness of listed private equity vehicles which facilitate access to a diversified private equity portfolio.’

There is certainly work to be done to point out to investors that such vehicles exist. Peter McKellar, of Standard Life European Private Equity Trust, argues, ‘iPEIT has done much to raise awareness of the listed private equity sector among institutions, wealth managers and advisers. Few realised the ease of access to an asset class that has outperformed the FTSE and MSCI indices over time for the price of a single share. That is now changing.’

Strong performance
However, the reason why investors should take notice of these vehicles is that they have shown a strong tendency to outperform portfolios of listed, or ‘public’, equities. Partners’ Group’s Tilman Trommsdorff argues, ‘There are systematic reasons why private equity outperforms public equity: you have much more involvement in, and information on, a private equity investment than you do buying shares in a public company; you can apply a much better financial structure when you are not under public scrutiny; also you have an exit strategy over, say, three to five years and you can manage for that, whereas, with a public company, you have to report quarterly or half-yearly and match benchmarks over that period. In addition, it is easier to incentivise management.

‘Global listed private equity has been growing – currently there are around 200 of these companies worldwide. For example, our investible universe would be about 80, and by investible we mean those with over £100 million market cap and at least £100,000 turnover per day.’

Trommsdorff notes that ‘The UK has probably led this process, but it is now growing elsewhere. There are two drivers of this. Venture capitalists and fund managers want to raise permanent capital, but there is also a growing demand from investors for private equity as an asset class.

‘On the one hand, limited partnerships have only really been available to institutional investors, because of their very high commitment levels and so on, but investment companies make private equity available for private investors. The man in the street can buy one share for ten euros, or whatever the share price is.’

Still upside potential?
But, given the uncertainty in global equity markets, have private investors missed the private equity boat? Following a period when private equity investment has been in the doldrums, the sector is looking attractive again. Urs Wietlisbach argues, ‘Listed private equity offers attractive relative value at the moment, with a number of vehicles trading at high discounts to NAV.’

Ian Armitage adds, ‘There is more demand from private investors. As they see more well-known companies, such as Boots and the AA, going into private equity hands, they will get more interested and more comfortable with investing in private equity, as it is the only way they can get exposure to these companies.’

Tilman Trommsdorff says, ‘Venture capitalists believe in the cycle, and  whatever statistics you use indicate that a cyclical peak has been passed. The deal rate is down 60 per cent, because the top end of the market – those deals above one million euros – is dead. Large deals drove the market and these relied on the ability to raise a lot of debt, which is just not available at the moment.’

He concludes, ‘Most coverage focuses on these big deals, but while these have dropped off, meaning the value of deals has fallen by 60 per cent, the total number of deals is only down by around 20 per cent, because the mid-market deals have held up pretty well. A good private equity manager will be able to play that cycle.’