Why private equity could boost your portfolio

As we discussed in this previous article, for many private investors in the UK, it may be worth considering an allocation to private equity.

Private equity backed companies typically represent a very different set of companies to those listed on the London Stock Exchange.

With investment trusts, private investors can access these opportunities with daily liquidity.

The AIC’s Listed Private Equity sector currently constitutes around 15 trusts, many of which have demonstrated strong returns over multiple cycles on a NAV basis.

These trusts invest in private companies – either directly or through private equity funds run by other managers. Each has its advantages and disadvantages, but NB Private Equity Partners (NBPE) bridges both approaches.

Uniquely among funds available to individual UK investors, it invests directly into companies alongside a variety of other private equity managers through ‘co-investing’.

Co-investing is a relatively widely-used method by which private equity sponsors or managers buying a company invite other investors (such as Neuberger Berman) into the deal.

They offer full transparency, but normally require a relatively quick decision from prospective co-investors. As such, it requires a specialist team able to analyse companies on a deal-by-deal basis, not to mention an excellent network to source such deals.

Investing through co-investments is a key advantage NBPE has, both in being able to put money to work in a timely fashion (matching cash coming back from investments), but also managing the shape of the portfolio.

NBPE currently has a portfolio of over 100 equity investments, which show the sort of concentration and diversification one would typically find within a fund investing into public equities.

‘balances the requirement to make meaningful investments in the team’s best investment ideas’

This means that the trust balances the requirement to make meaningful investments in the team’s best investment ideas (driving growth) with the benefits of diversifying risks across businesses and sectors (minimising specific risks).

Within this, the underlying portfolio has exposure to niches and business opportunities that are likely to be very different to those of passive investments, or other public equity funds.

NBPE is mostly invested in US headquartered businesses, but we compare the diversification its portfolio offers to those who already have an investment in the FTSE All Share tracker.

As the graph below shows, NBPE has a very different sector exposure to commonly-held UK funds, with a significantly higher allocation to some exciting and high growth sectors such as technology (which are almost completely unrepresented in the FTSE All Share).

It is noteworthy that NBPE has a relatively low exposure to those sectors which dominate the UK’s listed market – such as Energy, Financials and Basic Materials.

Tools for outperforming listed equities

Alongside having a very different overall portfolio make up, the underlying companies available to private equity investors can be distinct from public companies, in terms of both how they perform and how they are managed.

Indeed, companies controlled by private equity can have several advantages over equivalent public market companies.

First, private equity managers actively drive value creation through active ownership. This means that private equity managers take a real role in guiding the businesses they invest in.

Private equity managers, such as those that work on NBPE’s portfolio companies, often have detailed knowledge of specific sectors and the competitive landscapes within which companies operate, which means their advice can be highly valuable to companies.

‘companies controlled by private equity can have several advantages over equivalent public market companies’

Private equity managers also tend to invest for the longer term, which means their advice leans towards the real drivers of long-term growth, rather than those that produce short-term profit boosts – perhaps at the expense of the longer-term.

The combination of the company management and their private equity partners can mean that these private companies operate with significantly more expertise than similarly-sized public companies.

And because private equity managers have to live with their investment – for good or for bad – for quite some time, an enormous amount of research (or “due diligence”) is undertaken by managers to ensure that the companies they invest in, truly are what they think they are.

Private equity managers also try to ensure that, given they are investing over a number of years, there is a degree of risk mitigation should the original investment thesis not pan out.

This brings us to incentivisation. Another way that private equity investors aim to ensure their investments outperform is by ensuring the management team is highly incentivised to deliver and that the best management teams are therefore attracted to private businesses.

Structures are almost entirely based on equity incentivisation, with base costs kept as low as possible. This aligns investors with management – there are no private jets for the executive teams of most private equity-backed businesses!

Private equity delivers results…

Over time private equity can deliver returns ahead of public equity markets, although it is worth noting that the share price of NBPE may not always directly follow the changes in the trust’s net asset value (NAV).

Nevertheless, according to Morningstar, over the five years to 30 September 2019, NBPE’s NAV total returns in sterling have been 106% compared to the 81.5% total return for the MSCI ACWI Index in sterling.

While past performance is not a guide to future performance, NBPE has proven to be an excellent way to outperform public equity markets in the past.

At the same time, private equity offers investors the opportunity to gain access to companies and technologies driving modern economies forward, but as we have discussed, are perhaps choosing to resist ‘going public’ for longer. NBPE provides a good way for investors to get access to these exciting opportunities, through a simple and effective proposition.

_{Disclosure – Non-Independent Marketing Communication}

_{This is a non-independentmarketing communication commissioned by NB Private Equity Partners. The reporthas not been prepared in accordance with legal requirements designed to promotethe independence of investment research and is not subject to any prohibitionon the dealing ahead of the dissemination of investment research.}

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