Listed private equity struggles to drum up interest even from private investors. Anthony Harrington asks, does it have any role to play in institutional portfolios?
The unique offering of exchange-listed private equity funds, as the trade body LPEQ's strap line proclaims, is that it provides all types of investor with private equity-linked returns for the price of a share. "When people think about private equity, they think of limited partner (LP) funds which invest directly in PE opportunities," says Ross Butler, LPEQ's external affairs director. "However, the minimum ticket on these funds can be £10m or more and you are tying the money up for 10 years."
One would think that would be hugely attractive, at least to the retail investors that can't write those tickets. Andrew Lebus, a partner at fund-of-funds provider Pantheon, which has a 25-year-old listed fund called Pantheon International Participations (PIP), describes listed private equity (LPE) as "a great way for smaller long-term investors to get exposure to a divested portfolio of institutional-equity assets they normally wouldn't have access to." But Stuart Howard, a partner at HarbourVest, which has a listed product, still thinks that the sector has to get its act together and sell its message if it wants to get its "rightful" share of alternative portfolio type investments. "We have to get out there and tell them why it should be seen as a good asset class for private investors, as opposed to hedge funds or real estate, which is what they prefer at the moment," he says.
And that's before we even get to institutions. Pension funds - even smaller ones that might benefit from the ready liquidity and the ability to allocate smaller sums - are not exactly clamouring for the asset class. "We have a very varied client base, with small, medium and large schemes and, as yet, only a very small handful of schemes have exposure to PE via the listed market," says Sanjay Mistry, head of private equity research at Mercer.
Surprisingly, one reason is a problem with liquidity. After all, while some funds have been listed at least since the early 1980s, the entire LPE market still only amounts to around 5% of the whole private equity industry. "The total market size for listed PE is small and sometimes the shares simply don't trade," says Mistry. "Those who have them hold on to them. Buying a few million shares can be lengthy exercise."
Transparency is another issue. LPE providers point out that, unlike their limited partnership colleagues, they provide regular valuations. Monique Dumas, investor relations partner at Electra Partners, which manages a listed investment trust, concedes that while it can be difficult to find precise mark-to-market values for underlying holdings, funds get around this by finding comparable assets with known prices to provide regular net asset value (NAV) reports. But the market is generally sceptical of these NAVs - which is one reason why all LPE funds trade at a discount.
Another, more current explanation is offered by Peter McKellar, CIO at SL Capital Partners, a fund-of-funds provider with a listed vehicle. McKellar argues that discounts are down to investors chasing greater certainty, both in terms of yield and the timing of cash flows from their portfolios. "Private equity can offer outperformance, but it is irregular in its cash flows and it is very subject to the marginal seller and the marginal buyer," he says. As M&A activity picks up generally, and underlying private equity investments are sold, he expects discounts to narrow.
On the more positive side, are there specific advantages that LPE can bring to institutional investors? For those already committed to private equity limited partnerships, there is an argument that LPE could help to mitigate the so-called ‘j-curve'. It takes time for general partners to find and transact on investment opportunities after fundraising and, during the wait, limited partners might still be paying a management fee on the capital they have committed. Most limited partners are forced to hold a large part of that capital in low-risk or risk-free assets in order to preserve liquidity for when it is called by the general partner - effectively paying private equity fees on government bonds.
Some investors try to mitigate this by including a mandate to buy secondary interests in their private equity mandates - so that their portfolios can get exposure more quickly to investments that have been ‘in the ground' for some time already. Another option is to hold committed but uncalled capital in LPE instead of government bonds, achieving a certain amount of liquidity but also a genuine exposure to private equity return stream. And, as Lebus, at Pantheon, points out, it is also possible to combine the advantages of secondaries and LPE in a single security: PIP has a major part of its investments in secondaries and co-investments.
But the real appeal of this asset class has always been the opportunity it offers for outperformance versus the general public equity market. Alex Barr, head of private equity at Aberdeen Asset Management, which runs a listed fund of funds, expects an LPE investment to make a two-fold return over the life of the investment: "Over an eight-year period that gives you a compounded rate of 12-14% year on year."
Furthermore, it has long been accepted that private equity is a pure capital-growth play, but there is now some discussion in the LPE sector as to the benefits of paying some kind of dividend out of cash received from exits. Being closed-ended, LPE funds have generally reinvested exit profits to grow the base fund - but that bias is not written in stone. "This might well be a good argument for broadening the appeal of the sector," Barr says.
Perhaps the right way for institutional investors to think about LPE is not as private equity at all, but as a high-returning exposure to micro-cap growth equity.