Why listed venture capital is not ideal
Institutional investors interested in gaining exposure to private equity investment are being steered away from looking at listed vehicles, including venture capital trusts (VCTs) and private equity funds of funds. This is bad news for the private equity sector, reeling as it is already from the global economic downturn.
Kerrin Rosenberg, associate at Hewitt Bacon & Woodrow, discourages the listed VCT route. “Our clients want a one-stop shop, offering them the opportunity to get into the sector in a global and diversified way. These don’t do that.” He considers them an option only for very small pension funds that allocate less than £2-3m (E3-5m) to private equity, or for very large funds that have sufficient assets (and research muscle) to invest in a enough number of funds to achieve diversification that way.
When looking at private equity, liquidity is a major concern, especially for defined contribution arrangements, and traditionally it has been difficult to structure private equity exposure to fit with these demands. Quoted VCTs may seem to offer a solution, since they can be traded as and when.
But, maintains Rosenberg, “that liquidity is illusory”. He points out that sellers of quoted vehicles are still dependent on finding buyers. In addition, the secondary market for VC investment trusts may offer a more attractive option to investors emphasising liquidity and thus looking for a shorter-term commitment than the usual five to 10 year span.
Another problem with the listed VCT sector is that “there is not a huge number of vehicles at the moment,” says Phil Chesters, senior investment consultant at Mercers. In this way, the listed route may represent a potential growth area, if providers can find a way to structure their products to suit the needs of institutional investors.
The firms themselves don’t perceive the problems as insurmountable. For example, VC firm Caledonia has some investments in private equity funds itself: “When we see a good opportunity we get in,” says Jonathan Cartwright, finance director.
Both Rosenberg and Chesters currently promote the fund of funds route to those clients determined to enter the private equity market through a tradeable vehicle. Even then, however, their recommendation is tempered by the fact that, as Chesters put it, “there is only one fund of funds that we rate highly”. He declined to name his preference, but Hewitt's Rosenberg specified that Pantheon’s PIP is the only listed fund of funds that he would recommend. Even then, it is not an ideal choice, in his view.
Problems in the private equity fund of funds sector are well known, with many funds of funds finding it difficult to raise assets. A February 2003 study from AltAssets predicted that some 40% of the private equity funds of funds were destined for failure, particularly the newer entrants to the market provided by generalist asset managers. Like private equity itself, private equity funds of funds are best left to the specialists, who have the capacity to do the detailed research required and have the connections to raise funds.
A lot of compromises have to be made to fit private equity into a listed form. “The Pantheon investment trust is a very different portfolio than what they would give to their own institutional clients,” Rosenberg says.
The cash issue is a tricky one, not only for VCTs but also for funds of funds. “When you’re a fund of funds, you need to know how much money is available and then plan over two to three years, but venture capital trusts offer less understanding about cash flows,” says Rosenberg. Chesters seconded this. “PE trusts don’t know when they want money or when it will be realised. Its not a natural fit.” VCTs maintain high cash allocations at different stages in their lifecycles, sometimes as much as 30%. This is in part necessary as a buffer as investors move in and out, and in part necessary because the calls for cash come at various times. This means that investors, at best, are only partly invested in private equity. In addition, a decision has to be made about how to handle realisations – are they held as cash until the next call comes?
One other alternative is to invest in the PE companies themselves, rather than their products or investment trusts. This is an option with 3i, for example, which is a FTSE 100 company. “It gives you the opportunity to get into private equity in a highly liquid, very diversified, way,” says Douwe Cosign, corporate affairs director for 3i. “It’s a proxy for getting access to unquoteds and small caps.”