This article was taken from the September 2023 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.
Private equity (PE) has had a rough ride recently. Gone are the halcyon days of 2021 when investors were clamouring to gain access to both established and new funds across the market. Private equity limited partnerships have seen three straight quarters of declining investment amidst fears of persistently high interest rates and their knock-on effects on the growth prospects of smaller companies.
While many of these closed-end funds remain inaccessible to retail investors due to their high minimum investment thresholds, private equity investment trusts have been hit equally hard by this collapse in confidence. Trusts such as Harbour Vest Private Equity and Hg Capital are trading at discounts of 39.4% and 15.5%, respectively. There are, however, signs of life within the sector. We recently explored the opportunities and threats presented by these discounts. In this article, we will draw attention to the recent activity of one trust in particular, Hg Capital, and how its increasing trade activity paints a slightly rosier picture than public sentiment might be accounting for.
Hg Capital Trust (HGT) is a publicly traded private equity firm that invests in tech and software companies in Europe and North America, with target annual growth rates around the 20% mark. The trust has a long history of success and has outperformed global equity markets over the last five years. However, as of September 2023, it is yet to recover to the lofty heights it reached in April 2022. With IPO’s tailing off and secondary market activity seriously declining as companies become unwilling to reprice themselves to lower valuations, the sector seemed to have stagnated. We are beginning to see a turnaround here with IPO’s and trading activity starting to pick up. Hg Capital has itself had a recent flurry of activity. One notable partial sale has been that of TeamSystem, an Italian cloud software company, which HGT was able to move for around £33.3m. This represents an uplift of 68% from the carrying value of £19.8m in the trust’s net asset value (NAV). This is a positive sign as it indicates that other assets held by the trust may be seriously undervalued. Assets in private markets are notoriously difficult to value and, as such, it is important that we don’t jump to conclusions or extrapolate single pieces of data into long-term trends. Having said that, this is certainly good news.
This theory is backed up by the growth figures for the Trust’s top twenty holdings. The average revenue growth generated by these companies is around 30% per annum, and when we consider that the top twenty make up 77% of the Trust’s total value, it starts to look like perhaps HGT has been undervalued. Market perception of private equity has long been that valuations have to come down across the board as companies can no longer finance long-term growth by permanently borrowing money with exceptionally low interest rates. The trust has also undertaken in £1.4m worth of buybacks over the past year, indicating that its management believes its own portfolio is undervalued by the market, and this should help narrow the existing discount. What is particularly impressive is that it has managed to execute these buybacks without tapping into its revolving credit facility, meaning it still has a total of £689m of dry powder to invest into the market.
The counter argument to this is that unpredictable valuations are hardly reassuring, especially at a time when even public markets have been exceptionally volatile. This is a valid concern as private equity is an opaque market at the best of times and when valuations are this out of sync and discounts are this wide the market can start to feel chaotic. It may seem an obvious statement, but assets are only ever worth what someone will pay for them, and people will generally pay less for assets that are shrouded in uncertainty. Some uplift at the point of sale is also expected with private equity investments, so while the scale here does warrant some optimism, this is far from unheard of.
Private equity investments such as this are inherently risky. A lack of reporting requirements and significantly decreased transparency when compared to listed equities make them unpredictable. That said, the increased activity we are seeing in the space from trusts such as HGT is indeed promising. It shows us that quality companies, even in private markets, are finding ways to adapt to high interest rates and generate growth. There is a light at a the end of the tunnel.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.