Over the last few weeks, the median discount has been narrowing again, but it still stands at 24.7%, one of the widest median discounts for any part of the investment companies sector, according to analysis at investment trust research house QuotedData using Morningstar figures.
Many readers may think this is strange as many private equity funds are amongst the best performing investment companies over the past year. Funds such as Standard Life European Private Equity, Hg Capital, Princess Private Equity and Electra appear in the top 10% of best performing of all closed-end funds over the year to the end of April 2016, as shown by figures compiled by QuotedData.
The most common reason cited for private equity funds trading at wide discounts is their underlying investments are illiquid. However, this argument falls down quite quickly when you consider some investment company sectors that trade on the highest premiums are also invested in assets which in some cases are far more illiquid than private equity. This includes infrastructure, renewable energy and property.
This is even more true if you factor in the secondary market for private equity investments. For example, Standard Life European Private Equity’s managers say that the prices of secondary investments in the European based limited partnership vehicles it buys have been changing hands at discounts of less than 10%. They even sold an investment in one Apax fund at a premium.
Standard Life European Private Equity is one of a number of funds of private equity funds listed in London. Its managers, SL Capital Partners, believe that, even for a fund with assets of £470m, it is not really practical to make direct investments in unlisted companies and achieve adequate diversification. History has shown us that a lack of diversification has been a problem for some directly invested funds where one or two big investments have gone wrong – think about Candover and Expro International or Better Capital and CityLink. By investing in a fund of funds, you will end up with exposure to hundreds or even maybe thousands of underlying companies. This is one factor that helps smooth the NAV progression of these funds of funds.
The quid pro quo for investing via a fund of funds is these come with an extra layer of fees. However, the managers have large expert teams dedicated to analysing the underlying funds before they invest in them with the aim of delivering better risk adjusted returns, after costs, than could be achieved by investing directly.