Over the past few years, I’ve written about why private investors might want to invest in private assets and especially equity, usually through a listed investment trust. At its very simplest, there are more high-growth businesses that are choosing to avoid the public markets and opting to stay private for longer, aided by private equity funds.
So, if as an investor you want some exposure to these higher-growth private businesses, you are forced to consider the broad spectrum of funds ranging from early stage venture capital through to buyout funds for mature companies.
I don’t want to undersell the challenges. Private equity is riddled with excessive fees for clients. The share prices of even well established, successful listed funds are heavily discounted against their net asset value. Those discounts showing no signs of shrinking any time soon.
Private equity has boomed partly because of its access to cheap money in the past decade or so, enabling substantial leverage in many cases. That era is now coming to an end as debt servicing costs have shot up and anecdotally I hear plenty of PE types fretting about having to move IRRs — internal rates of return — from the high single digits to mid or even high teens.
This last trend — higher interest rates forcing up the returns needed from investing in risky private businesses — is a very real challenge and will sort the wheat from the chaff. For too long, PE professionals have said they are experts at running businesses, investing for growth and improving operating margins, as well as financial engineering, but now they’ll have to prove it. They’ll have to show very clearly how they can add value, with less debt and higher thresholds for returns.
I’m not sure all managers will pass this test and the trick for investors will be to understand who has access to the right deals, which will in turn force managers to hunt out more adventurous propositions — and not just rely on debt-fuelled mega deals comprising packages of well known businesses.
It is against this backdrop that I’m going to suggest three private equity or venture capital funds that are adventurous in their attitude to deals. They sit on the fringe of the mainstream — easily accessible listed private equity funds such as Hg Capital Trust, Oakley Capital Investments or fund of funds such as Pantheon International or HarbourVest Global Private Equity. I have mentioned all of these in a previous column on PE and any could easily sit in a private investor’s portfolio.
The first of my bolder propositions is Literacy Capital. It has the distinction of being almost the only PE fund listed on the London stock exchange — apart from 3i — that trades at near to par and has even traded very recently at a premium. It occupies a very particular and compelling niche: it invests in fast-growing, but established, UK focused smaller businesses, with deals typically in the £1mn to £10mn range.
That UK small deal focus is highly unusual among listed PE funds, but be assured this is not a venture capital operation. Most of its portfolio businesses are either profitable or close to being profitable and fairly established in their market.
Most private equity managers listed on the stock market tend to look to continental European and focus more on deals in the £50mn plus range, many in the billions; Literacy Capital is happy to work with much smaller businesses it can scale up. In effect it’s a kind of public family office for Paul Pindar (and his son) who founded outsourcing specialist Capita.
It has had several very successful exits, including a recent one involving a pet foods business that generated a huge multiple on investment. The fund also has a clear ESG focus, donating a portion of its fees to a sister charity that works to improve literacy in schools. If, like me, you think there’s a huge funding gap for non-technology growth companies in the UK, in sectors as varied as recruitment and food, then this is the fund for you.
Sticking with the UK theme but going much further up the risk curve, it’s also worth watching a listed VC called Forward Partners. If I had to draw up a list of all the investment niches not to be in at the moment, this would probably win the prize. It invests in early-stage businesses, where funding has dried up in the past few months. Its UK focus means it doesn’t really have much chance of getting any local IPOs away any time soon. It has also featured ecommerce as a core area and as a small fund doesn’t have the deep pockets of some of its bigger VC peers. That means it needs capital to help its portfolio businesses get through the next two to three years.
Not unsurprisingly, investors have taken a look at the portfolio and pencilled in a huge haircut on valuations, with the fund trading at a near 70 per cent discount to net asset value. In my view that’s deserved at the moment because I’m not sure I’d trust any valuation of a private VC investment based on 2022 numbers or, frankly, even some 2023 figures. Forward is therefore in an entirely unfashionable spot — but dig around its portfolio and quite a few of its businesses look compelling, especially those in AI, where the UK has real strengths.
My last suggestion is another challenger for that least-loved status. Georgia Capital is one of the biggest international investors in Georgia — not the US state but the charming republic nestled up against Russia (and two breakaway states).
I can instantly imagine the thoughts flashing across readers’ minds, but consider this: Georgia Capital has one of the most impressive records I’ve seen for building up private businesses, then selling them on or listing them. It is investing in a booming economy and sits on a big stake in London-listed Bank of Georgia, which is also booming, and has higher profitability than pretty much any UK bank.
Compared with most emerging markets private equity outfits listed on the London market, it’s a paragon of transparency and its management has gone out of its way to explain its PE business model. All to no avail: the fund trades at a 56 per cent discount to its NAV, and that is despite its share price rising by 41 per cent in the year to date.
What binds all three of these London-listed funds is that they push the envelope of the private equity model by going to places that most big operators won’t touch with a barge pole, and generating real alpha by taking big risks. That means smaller private growth businesses in the case of Literacy Capital, early-stage tech businesses at Forward or frontier markets with Georgia Capital.
All have a proven record of deals and exits, but are under the radar of most mainstream UK investors, even those interested in off-market assets such as private equity. And I now own shares in all three, having drip-fed money into the funds in the past six months.
David Stevenson is an active private investor. Email: [email protected]. Twitter: @advinvestor.
