The case for the asset class - considerations for investors
Access to private capital investing through limited partnership funds, the most common investment vehicle, is in practice only available to large, sophisticated investors, due to large investment-size requirements, complex regulatory/legal considerations, and the limited liquidity offered.
Listed private capital enables a much wider range of investors to invest in this asset class through the stock market, avoiding the complexity and illiquidity of limited partnerships. Adding private capital to a traditional portfolio through listed private capital can access assets and investment strategies not found in public markets, and thus boost returns, enhance yield, and improve portfolio diversification. The two main ways for gaining exposure to private capital are investment in listed private capital companies, and in listed funds.
A listed private capital company is a closed-end investment company. Such companies generally invest like a limited partner in a private capital fund, with a general partner (“GP”) managing the investments. Occasionally, a listed private capital company will own the GP or directly employ the investment team (known as “self-managed”). Listed private capital companies can pursue a direct investment strategy, or a multi-manager/fund-of- funds strategy.
Key considerations for investors include:
- With the minimum investment being one share, listed private capital unlocks for private investors and smaller institutions the diverse opportunities available in private capital. The shares of a listed private capital company or fund are traded on an exchange, giving clear valuation and daily liquidity.
- As trading volumes in listed private capital companies’ shares can sometimes constrain liquidity, some investors invest via a listed fund, which itself holds shares of listed private capital companies and asset management companies focused on private capital. These tend to be open-ended funds or exchange-traded funds.
- Most listed private capital companies and funds in Europe are listed on a main-market exchange and subject to the full range of governance and risk management obligations.
- The complexity and time involved in valuing private companies means that portfolio valuations tend to be undertaken quarterly or semi-annually, unlike the daily valuations commonly provided by investment trusts. This gives rise to concerns about the robustness of valuations. Valuations are carried out in accordance with IFRS and well-established industry guidelines around “fair value” reporting, but these inherently involve a degree of judgement.
- Costs and fees are important for investors. The private capital investment model involves intensive input by highly-skilled practitioners across each investment’s life-cycle. It is a higher return, higher cost investment management model, aligning the interests of investment managers, management teams and investors. In addition to the management fees and carried interest that a listed private capital company may incur as a limited partner, it also incurs its own running costs.
- Like other closed-end investment companies, the share price can be higher or lower than the underlying NAV, reflecting factors including market sentiment, past performance and outlook, dividend yield, shareholding structure and trading volumes. Listed private capital companies, because of the complexity of valuing private investments, tend to update NAVs quarterly or semi-annually, and report them with a time-lag of a month or more. This can give rise to uncertainty about NAV, particularly in volatile markets.
- Some listed private capital companies demonstrate their commitment to shareholder value through share buy-backs during periods of elevated discounts, or adopt more generous distribution policies. Historically listed private capital companies would make distributions only from revenue reserves, but more recently some have paid higher dividends from realised capital profits. While the sustainablity of such dividends can be questioned, given that they rely to some extent on realisations, the counter argument is that as listed private capital companies exist to buy, improve and sell their investments, the profits from this core activity should be distributed.
- Before the financial crisis, some listed private capital companies deployed leverage at the listed company level or used over-commitment strategies – both with the aim of managing balance sheets efficiently. Boards are now taking a significantly more prudent line on both balance sheet leverage and over-commitment strategies. Enhanced risk management processes, and greater transparency and disclosure have been widely introduced to give investors a clearer picture of investment management strategies and use of leverage.