Recent turmoil in global markets has prompted fund managers to reassess risk, especially for US bank stocks.
But one strategy seems to be surviving the inventory, as have the ups and downs of the last three years: the pursuit of private markets.
If you believe the hype around private assets, the old model of managing your money through a long stock only fund run by a stock fund manager is “out of date” and everything private is in it.
This means a wide spectrum, from private equity and venture capital to private debt, where the underlying investment (or borrower) is a private company that is not listed on the stock exchange.
Attraction? Well, one suspects that higher fees help attract fund managers, as does lower levels of reporting (nasty companies don’t have to file quarterly reports). There are also longer investment periods, a more patient approach and of course higher leverage.
A cynic might say that as a private investor you should stay away from this: you will find yourself in less liquid structures with higher fees. I certainly think that anyone with less than £100,000 is best off sticking with simpler tariffs like tracking funds. But I would add that an adventurous investor with a few hundred thousand pounds could dabble in this area with, say, 10 to 15 per cent of his portfolio.
The evidence, while not entirely conclusive, suggests that many private asset classes, such as private equity (PE), have yielded significantly greater returns than publicly traded assets (stocks and bonds) over the past decade. Since the 2008 financial crisis, the EP has outperformed major equity benchmarks.
That said, it’s worth noting that the correlation between PE as an asset class and major equity benchmarks over the past decade has been around 0.7, suggesting a very real link between volatile equity markets and private equity, though not identical returns.
One can only guess whether it will be the same in the next two decades, especially as interest rates rise, but investors should consider how they can access private assets. Large institutional investors now routinely invest more than 30 percent of their portfolios in private assets, although I think that sounds far too much to most risk-averse private investors.
The good news is that there are more readily available funds that allow you to get into different niches in the spectrum of private assets. Private equity is the most established; in this space, buyouts of large enterprises constitute the largest component. Asset managers such as Blackstone, Carlyle and Apollo dominate this area, but London-listed 3i is a respected player with a great track record – its share price has increased sixfold in the last decade.
I would also like to highlight two established private equity players, Pantheon International and HarbourVest. Both have LSE-listed funds that give you access to a huge range of underlying funds, with large discounts – both over 40 percent – to their net asset value. In my view, we are probably much closer to the bottom of the private equity valuation cycle for buyouts as an asset class. Of course, it’s still possible for valuations to fall even further if we hit a nasty recession.
I’d also like to point out hybrid companies like Melrose, which is actually a buyout operator that buys up key industrial companies and then converts them like a PE house to spin them off – just as it did with Dowlais, GKN’s old auto parts business. By the way, I’d also point out Halma, another publicly traded industrial company that likes to buy from the right company and then impose its own corporate approach on it – much like Danaher in the US, whose share price has more than doubled in five years.
But private equity is much more than just big buyouts. A number of specialists are targeting slightly smaller (although still large-capitalization) companies, but focusing on operational transformation and using technology to scale the core business. In this field, a notable success story on the UK Stock Exchange is Hg Capital with Oakley Capital Investments focusing on growing tech-driven businesses. Oakley in particular has a high-quality portfolio, but its stock is trading at a heavy discount.
Even these niche players tend to work with larger companies. If you want to target your firepower at smaller cap companies – between £1m and £50m – your best bet is a start-up fund called Literacy Capital, which was listed on the London market a few years ago and boasts a very focused strategy in the UK .
Beyond ‘traditional’ PE, we move on to venture capital that ranges from late-stage pre-IPO ventures – which are the focus of the approach of London-based Chrysalis Investments as well as the Scottish Mortgage Investment Trust’s large private portfolio – to investing in the seeds of very early stage starts. In terms of market cycles, I still think it’s way from the bottom of the valuation cycle, although it’s getting closer month by month. However, keep in mind that the listed VC space is very volatile and should only be in the riskiest part of your portfolio.
UK investors typically access this space through one of two routes. The most popular are VC funds with generous tax incentives, where companies like Octopus and Baronsmead are leading players. Tax incentives are offered because it is a very risky space with many potential downsides. Another alternative is to use a crowdfunding platform like Seedrs and Crowdcube, where the focus is on really early-stage companies. Again, the risk is very high – out of my portfolio of over 20 small stakes, at least four companies have gone bankrupt in just a few years.
I still own stakes in companies on both platforms, but I would argue that scale breeds access to quality offerings. Just as large buyout shops have the firepower and staff to run large deals, large VC firms have the infrastructure to build well-researched, diversified portfolios of high-growth companies. In this category, the British market offers Molten Ventures, a British listed group.
There are also direct online platforms like Moonfare. This innovative online platform allows you to invest directly in well-established PE funds and VC funds at an earlier stage, on terms usually available only to large institutional investors.
Private debt and private credit is another fast-growing segment of the private asset spectrum. The Intermediate Capital Group is a significant player in this space. There are also specialized private lenders that lend directly to a smaller company through a debt package. The most established player in the London market is Pollen Street Capital, a London-listed asset management firm that manages private equity funds but also invests through technology-equipped lending firms in everything from SMEs to casual private clients.
What is my strategy for including this broad class of private assets in my portfolio? I like VC investments to be around 10 percent of my total portfolio exposure. I also like that traditional PEs are about the same level, usually through a publicly traded private equity offering or directly through Oakley and Hg Capital in my case.
I figured buyouts could be profitable, especially for more mature industrial companies, but I’d prefer to do it through London Stock Exchange listed companies like Melrose, Halma and Danaher.
David Stevenson is an active private investor. He owns Scottish Mortgage, Molten Ventures, Chrysalis, Melrose, Halma and Danaher. E-mail: email@example.com. Twitter: @counselor.