The Unusual Opportunity In PE Investment Trusts

18th Jun by Graham Neary

31 comments 2827 reads

In my recent hunt for capital gains, private equity investment trusts are a sector that have popped up, and in which I have started investing. I’m a relative newcomer to the sector, seeing as I’ve mostly focused on single stocks during my career, but I thought I would share an overview of my findings with you.

Firstly, why might you care about this sector? Well, I think it offers a range of interesting features:

Diversification away from the public equity markets, which might be helpful as the S&P500/Mag 7 nearly always appear overvalued to me, and I already have plenty of exposure to UK single stocks..
Many of these trusts have historically offered returns that are competitive with the broader public stock markets.
These high returns might be expected to continue long-term as they should benefit from the small-cap premium (the investee companies are often SMEs).
Where we are looking at HMRC-authorised investment trusts, they enjoy tax privileges, i.e. exemption from taxes on chargeable gains (please do your own due diligence on this topic!).
Many of these trusts trade at wide discounts to NAV, and have management teams who are keen to narrow these discounts back to levels at which they traded historically.

For every advantage, I’m sure you can probably find a disadvantage or a potential risk - for example, there is no guarantee that the discounts to NAV will narrow from current levels. But still, I do think that it’s a sector that has the potential to beat the stock market indices, while taking less risk than single-stock bets. So for a relatively conservative section of my portfolio, I think it has a role to play.

So with that said, here is my overview of private equity investment trusts. I’ll start with the smallest and most obscure, making my way towards the largest and most blue-chip trusts.

(Please note that I’m leaving out 3i (LON:III) from my analysis as its top holding is responsible for 72% of NAV. Therefore, while it is technically an investment trust, it doesn’t offer the diversification that I’m looking for when making a new investment in the sector.)

LMS Capital (LON:LMS) (£17m)

The strategy at LMS is to invest in “companies that generally require a level of management attention which larger funds are unable to support…

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icm

19th Jun

I think the fees are taken from the capital which reduces the NAV. I hold (pleasingly) about half of the ones mentioned and the fee taking is all back room stuff.

Been drip buying Pantheon International (LON:PIN) since about 2001, over the last ten years, an annual return of 8.7%, though since covid the discount to NAV has been a lot higher on average than historically - seems to take a dive when the market goes down, bigger than the index, then takes a long time to pick up, a phase it is going through at the moment.

Steve L

Thanks for the article, its very much appreciated. The Private Equity market seemed huge and the fund charges varied greatly between managers so I accepted I would probably drive myself crazy trying to research this field in detail and went looking for PE ETFs, of which there are relatively few. Eventually I plumped for iShares Listed Private Equity UCITS ETF USD D (LON:IPRV) which may be of interest. Its charges appear lower than actively managed funds, it offers a reasonable dividend payment and has returned 65% over 5 years (higher if the divi is included). Might be worth considering for those hard pressed for time to conduct extensive research.

Charles Mitchell

Great overview Graham. PE trusts are often covered in the monthly investment trustthread- Junes Monthly There a re a couple of very specialist trusts - Augmentum Fintech (LON:AUGM) and Hydrogenone Capital Growth (LON:HGEN) . Both trading on large discounts and both boards have said they are aware of the need to address the discount. Time will tell. Fees are always complex with PE trusts, some have a bonus above a certain return. Also many of them invest in other PE funds rather than direct, so can be difficult to get to the underlying portfolio. I am a long term holder in Oakley Capital Investments (LON:OCI) which has done OK andHGEN and AUGM where the asset performance has not been too bad , but share price fallen a lot due to the widening discount.

OldSchool05

Hi Graham,

Thanks for this article. I am less keen on Pantheon International (LON:PIN) and Harbourvest Global Private Equity (LON:HVPE) as I think they are very difficult to understand given the 'fund of funds' investment profile. Very hard to look through.

The best site for Investment Trusts, apart from Charles Mitchell's Discussion Board (here on Stocko), is to keep an eye on the AIC's website. https://www.theaic.co.uk/

The performance of fund of funds style Trusts has been mixed over recent years. 5 year record of Pantheon International (LON:PIN) is a total return of 54.8% and Harbourvest Global Private Equity (LON:HVPE) is similar at 54.2%.

I much prefer those Trusts which are more focused on driving results from individual holdings and less diversified. I tend to have around 10% of my invested funds in this area, and have focussed on Oakley Capital Investments (LON:OCI) and HgCapital Trust (LON:HGT) for this sector. The way I look at it is even if HgCapital Trust (LON:HGT) largest holding is 15% of its portfolio, that only translates to 0.75% of my invested wealth (on a 5% portfolio position).

I routinely take larger risks on other single holdings, such as Spectra Systems (LON:SPSY) and Volvere (LON:VLE) which are around 7.5% of my invested wealth individually.

Oakley Capital Investments (LON:OCI) has delivered very strong returns over the last 5 years of 157% and HgCapital Trust (LON:HGT) has closely followed that at 126%. It is rare to buy HGT on a discount, and the current 8% discount quite possibly represents an excellent long term opportunity.

If I had to choose just one Trust, it would be Oakley Capital Investments (LON:OCI) . Their reporting is excellent, winning awards in recent years for investor relations. They are led by Peter Dubens, who holds a huge 11.5% of the stock and routinely makes chunky purchases. They are European focused, so give me a good hedge for my Pershing Square Holdings (LON:PSH) US focussed trust holding. They tend to be the first investor that founder-led entrepreneurs turn to, often taking shareholdings in private companies without competition from other PE funds.

Personally, I have learnt to ignore the charges on these Trusts and just focus on the total return that you can get when held over the long term.

sevenccc

Agree Icm

The charges issue seems to me like part of the obfuscation from our financial services providers to channel our investment choices and discourage investment in this area. If I recall correctly Halifax also list all these costs which put a friend off the sector some years back. Surely all that matters to us as investors are the SP, NAV and any yield. The rest is included in NAV.

Dave R

I think you may have unintentionally highlighted Grahams point that it may be worth paying high fees in this sector. Whilst the ETF does have low fees itself, it basically invests in other companies/funds, so they are (to my mind) a type of "fund of funds" (but with lower published fees). All the funds they invest in will also be charging fees. It's performance puts in in the low end of the top ten PE ITs according to Trustnet. Probably a lot of their performance is due to 3i being their number 1 holding (8.5% weighting).

I've never considered this but can ETFs have a premium/discount to NAV or are they priced at NAV? this could be a bonus for PE ETFs if they trade at NAV.

ken mitchell

I don’t think the charges are anywhere near as high as some that have been posted here today but it needs someone more clued up on charges than I am, to confirm that. Like OldSchool05 I focus on the investment case for the Trusts I hold and seek out and their performance.

Private Equity Trusts have been out of favour for a good while now but that’s throwing off some tempting buy opportunities. I also hold Oakley Capital Investments (LON:OCI) and bought in 2019, and it’s in the Virtual Investment Trust portfolio, published at the beginning of each month by poster number33 on the Investment Trust thread.

HgCapital Trust (LON:HGT) looks very tempting now. For years it traded at a premium. OK. At 7% the discount is tiny compared with the huge discounts available on some of the others. But why did it trade at a premium for so long? Excellent performance along with never having to dispose of an investment for less than they paid for it! Note though the poor 1 year share performance. That’s surely temporary?

OldSchool05 posted a link to the AIC website.

The AIC is the trade body for Investment Trusts and was founded in 1932. It covers all the Trusts and sectors and there’s a wealth of information there.

The link below is for all the Private Equity Trusts to see at a glance must know figures and comparisons for all of them, and allow one page. Click on each Trust highlighted in red to bring up a lot more information just for that Trust. (The exceptions are the very few Trusts that don’t subscribe to AIC).

The same can then be done from that link using the appropriate search button for every Investment Trust sector and every Trust in that sector.

An alternative quick way to find those pages is to Google AIC Compare Companies.

Highlighting the link below also shows the extraordinary gains for 3i (LON:III) . But that success was thanks to one stunningly successful investment that is now a huge chunk of their portfolio. It’s too late to invest now. 3i (LON:III) is trading at a ludicrous premium to NAV.

https://www.theaic.co.uk/aic/f...

Finally, another sector where Trusts that used to trade at Premiums but now traded at big discounts are the Renewable Infrastructure Trusts. They are difficult to assess but the sometimes double digit dividend yields (e.g SDCL Efficiency Income Trust (LON:SEIT) 14% dividend ahead of recent share price bounce) ) along with sector consolidation likely, makes them worth checking out too. Some are getting regular coverage on the Investment Trust threads here run by Charles Mitchell. I hold several of them.

Here’s the AIC link for all the Renewable Energy Infrastructure Trusts:-

https://www.theaic.co.uk/aic/f...

Hi Dave. I'm under the impression that significant premiums or discounts to NAV are rebalanced back to NAV by a process called "creation-redemption" which involves creating or withdrawing the number of ETF shares available in the market. Not quite sure how it works, or how efficient it is during times of extreme market volatility.

JamesS

Great thanks

I. should. have said re the AIC site, the performance figures for the PE sector the aiC use are totally skewed by the crazy (in my opinion) value attributed to 3i (LON:III) . Strip. out III and you get a better picture of the winners and losers.

Bouden54

3i is extremely overvalued and heading for a fall at some point, in my opinion. Not only is it on a 60% premium, but Action (which makes up the bulk of the port) is valued on a very high multiple which means the NAV is inflated. Just my view and might be completely wrong.

The ETF itself might not charge high fees but the PE funds it holds will all be charging those fees, so I wouldn't use that as a basis for holding it (although not necessarily a bad choice if you want diversified exposure to the PE sector)

Agree not sure why private equity fees are always such a huge issue for investors - private equity is an expensive business but as long as they deliver good returns I'm happy to pay. I don't see many people complaining that they won't invest in, say, Apple or Microsoft because management salaries are too high - you just focus on the net profit once all expenses deducted and work from there.

My view entirely .

peterthegreat

Also worth examining the strategies of some of these investment trusts. For example although HgCapital Trust, Oakley Capital and Literacy Capital apparently have few similarities, they all, to a greater or lesser extent, include some investments which are serial acquirers so a significant part of their portfolio can growth inorganically. I think this is one factor which has helped in long term success of HgCapital Trust and Oakley Capital but perhaps we need to wait a bit longer before we can say the same of Literacy Capital. I own all three for this reason.

20th Jun

Thanks. For info I got this from Gemini AI that confirms what you said.

ETFs can trade at a premium or discount to their Net Asset Value (NAV), similar to investment trusts, although the mechanism and typical deviations tend to be different.

Here's a breakdown:

ETFs (Exchange-Traded Funds):

* NAV: The NAV of an ETF represents the value of its underlying assets (stocks, bonds, etc.) minus liabilities, divided by the number of shares outstanding. This is calculated at the end of each trading day. Many ETFs also provide an indicative NAV (iNAV) throughout the trading day, which is an estimate of the real-time value of the underlying holdings.

* Market Price: ETFs trade on exchanges like individual stocks, and their market price is determined by supply and demand during trading hours.

* Premiums and Discounts:

* Premium: When the ETF's market price is higher than its NAV.

* Discount: When the ETF's market price is lower than its NAV.

* Arbitrage Mechanism: This is the key difference from investment trusts. ETFs have a unique "creation/redemption" mechanism involving Authorized Participants (APs).

* If an ETF trades at a premium, APs can create new ETF shares by buying the underlying assets and delivering them to the ETF issuer in exchange for new ETF shares. They then sell these new shares on the open market, profiting from the premium and increasing the supply of ETF shares, which pushes the market price back towards the NAV.

* If an ETF trades at a discount, APs can buy ETF shares on the open market and redeem them with the ETF issuer for the underlying assets. They then sell these underlying assets, profiting from the discount and reducing the supply of ETF shares, which pushes the market price back towards the NAV.

* This arbitrage process generally keeps ETF market prices very close to their NAV in normal market conditions. Deviations are usually small (e.g., a few basis points).

* Reasons for deviations: While arbitrage keeps premiums/discounts tight, some factors can lead to temporary or slightly larger deviations:

* Market Volatility: In highly volatile markets, the arbitrage mechanism might not keep up perfectly, or the pricing of underlying assets might be less clear.

* Time Zone Differences: If an ETF holds assets that trade on exchanges in different time zones, the iNAV might be based on stale prices, while the ETF's market price reflects real-time sentiment.

* Illiquid Underlying Assets: ETFs holding less liquid assets (like some bonds or niche commodities) may experience wider premiums/discounts as the arbitrage process is less efficient.

* Trading Hours: During periods when the underlying markets are closed, but the ETF still trades, the ETF's price can deviate as it acts as a price discovery mechanism for the underlying assets.

In summary:

Both ETFs and investment trusts can trade at premiums or discounts to NAV. However, the arbitrage mechanism in ETFs typically ensures that these deviations are much smaller and more transient than those commonly observed in investment trusts, which have a fixed share count and whose market price is more directly influenced by investor supply and demand for their shares.

John O' Gaunt

22nd Jun

Belated thanks, Graham. Your article has significantly added to my (very limited) knowledge of equity investing.

The only trust in this field that I currently hold is Oakley Capital Investments (LON:OCI) . Of the rest, the one that stands out for me is ICG Enterprise Trust (LON:ICGT) . It has a good 5 and 10-year performance, a 35% discount to NAV and is buying back a few of its shares. In addition, the NAV only ever seems to go up! If you or anyone else can tell me what I'm missing, I'd be grateful. If not, don't worry because I won't be putting my shirt on it.

Jfox

24th Jun

This is a helpful roundup. One point you omitted is that JZ is in wind-up mode which should bring forward the elimination of the discount.

26th Jun

PPET released their half year report today. An interesting read as it gives some general guidance on the PE landscape and outlook.

Also read on another forum (advfn) an interesting take on European focused trusts. The idea was they have a significant edge on the relatively undervalued European PE space as the US based PE funds have language and cultural barriers. Not sure how true but food for thought.

The unusual opportunity in PE Investment Trusts

LMS Capital (LON:LMS) (£17m)

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Graham Neary

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