The latest bout of turmoil in global markets has sent fund managers scurrying to reassess their risks, not least in US banking shares.
But one strategy seems likely to survive the stock take, just as it has the ups and downs of the past three years: the drive to private markets.
If you believe the hype surrounding private assets, the old model of managing your money via a long-only fund run by a stock picking manager is “out” and everything private is in.
That means a broad spectrum from private equity and venture capital to private debt, where the underlying investment (or borrower) is a private business that is not listed on a stock market.
The attraction? Well, you might suspect that higher fees help attract fund managers, as do lower levels of reporting (the pesky companies don’t need to keep filing quarterly reports). There’s also the longer time periods for investing, a more patient approach and, of course, higher leverage.
The cynic might say you, as a private investor, should stay away from this: you’ll find yourself locked into more illiquid structures, with those higher fees. I certainly think anyone with less than £100,000 is best advised to stick to plainer fare such as tracker 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 their portfolio.
The evidence, though not entirely conclusive, suggests that many private asset classes such as private equity (PE) have in the past decade or so returned much more than assets from public markets (equities and bonds). PE has outperformed mainstream equity benchmarks since the financial crisis of 2008.
That said, it is worth noting that the correlation between PE as an asset class and major equity benchmarks over the past decade was around 0.7, which implies a very real relationship between volatile stock markets and private equity, though not identical returns.
Whether this will be the same in the next two decades, especially as interest rates increase, is anyone’s guess, but it makes sense for investors to consider how they might access private assets. Big institutional investors are now routinely allocating more than 30 per cent of their portfolios to private assets, though I think that sounds far too high for most risk-averse private investors.
The good news is that there are more easy-to-access fund vehicles to get into various niches within the private asset’s spectrum. The most established is private equity; within that space the biggest component comprises buyouts of large businesses. Asset managers such as Blackstone, Carlyle and Apollo dominate in this space but London-listed 3i is a well-respected player with a great record — its share price has gone up sixfold in the past decade.
I’d also highlight the two established fund-of-fund private equity listed players, Pantheon International and HarbourVest. Both have LSE-listed funds that give you access to a huge range of underlying funds, with big chunky discounts — in both cases of over 40 per cent — to their net asset value. My own sense is that we’re probably a lot closer to the bottom of the valuation cycle for buyout private equity as an asset class. It’s still possible, of course, that valuations fall even further if we hit a nasty recession.
I’d also note hybrid outfits such as Melrose, in effect a buyout operator that snaps up key industrial firms then transforms them like a PE house with the aim of spinning them off — as it has just done with Dowlais, the old GKN automotives components business. At a push I’d also highlight Halma, another acquisitive listed industrial that likes to buy in the right company and then overlay its own corporate approach — as does Danaher in the US, whose share price has more than doubled over five years.
But private equity is much more than just large buyout firms. A range of specialists target slightly smaller (though still large-cap) businesses, but with a focus on operational transformation and using technology to scale up the underlying business. In this space the standout success on the UK stock market is Hg Capital, alongside Oakley Capital Investments, both of which have a focus on technology-enabled growth businesses. Oakley in particular has a quality portfolio, but its shares trade at a big discount.
Even these niche players tend to work with larger businesses. If you want to target your firepower on smaller-cap businesses — worth anything from £1mn to £50mn — your best bet is a newbie fund called Literacy Capital which listed a few years ago on the London market and boasts a very focused UK strategy.
Beyond “traditional” PE, we move into venture capital, which covers late-stage pre-IPO businesses — the focus of London-listed Chrysalis Investments’ approach as well as Scottish Mortgage Investment Trust’s large private portfolio — through to seed investing in very early stage start-ups. In terms of market cycles, I still think this is some way from the bottom of the valuation cycle, albeit getting closer by the month. Be aware, though, that the listed VC space is hugely volatile and should only ever sit in the most risky bit of your portfolio.
UK investors typically access this space via one of two routes. The most popular is VC trusts with their generous tax incentives, where the leading players are businesses such as Octopus and Baronsmead. The tax incentives are offered because this is a highly risky space with lots of potential downside. The other alternative is using a crowdfunding platform such as Seedrs and Crowdcube, where the emphasis is on really early-stage businesses. Again, the risk is very high — out of my portfolio of more than 20 small stakes at least four businesses have gone bust in just a few years.
I still own shares in businesses on both platforms but I’d argue that scale begets access to the quality deals. Just as the large buyout shops have the firepower and headcount to run big deals, large-scale VC firms have the infrastructure to build well researched, diversified portfolios of fast growth companies. In that category, the UK market offers Molten Ventures, a UK listed group.
There are also direct, web-based platforms such as Moonfare. This innovative online platform allows you to invest directly into well established PE as well as earlier-stage VC funds, on terms that are usually only available to large institutional investors.
Private debt and private credit is another fast growing bit of the private assets spectrum. Intermediate Capital Group is a major player in this space. There are also specialist private lenders, who will lend directly to a smaller business via a debt package. The most established player on the London market is Pollen Street Capital, a London-listed asset manager that runs private equity money but also invests via tech-enabled lending businesses to everything from SMEs through to ordinary private customers.
What’s my strategy for incorporating this broad category of private assets in my portfolio? I like VC investments to be about 10 per cent of my total portfolio exposure. I also like traditional PE to be around the same level, usually through a listed fund-of-fund private equity offering or directly through Oakley and Hg Capital in my case.
I’ve taken the view that there is money to be made in the buyout approach, especially involving more mature industrial businesses — but I’d rather run that through London-listed businesses such as Melrose, Halma and Danaher.
David Stevenson is an active private investor. He holds Scottish Mortgage, Molten Ventures, Chrysalis, Melrose, Halma and Danaher. Email: adventurous@ft.com. Twitter: @advinvestor.
