The strong appeal of private equity
HarbourVest is a fund-of-funds providing cheap access to fast-growing unlisted companies
The popularity of any investment trust, and hence the discount or premium to net asset value (NAV) at which its shares trade, ought in theory to reflect its historic performance and its prospects for the future. Investors, however, are far from rational. A trust that has grown its NAV by 251% in ten years, doubling it in five, compared with the FTSE All-World index’s total return of 138%, ought to be a market darling. But the shares of HarbourVest Global Private Equity (LSE: HVPE) trade at a discount of over 40%.
Doesn’t that suggest that its portfolio is massively overvalued? That argument might be plausible if stockmarkets had crashed, the world was facing recession, valuations were defying gravity and disposals had ground to a halt. But markets have been rising steadily against a benign economic backdrop. The average valuation multiple for a representative sample of the portfolio at year end was a reasonable 14 times cash flow, average cash flow having increased 15% in the year.
A conservative valuation
In the year to 31 January 2024, around 10% of the portfolio was sold at an average premium to carrying value of 24%, which suggests that the portfolio valuation is conservative. A conservative valuation makes it easy to continue generating uplifts in the future. One of HVPE’s largest investments, accounting for 2.1% of the portfolio, is Chinese fast-fashion group Shein, expected to list in London soon.
Why, then, doesn’t HVPE buy back shares at such a discount? Actually, it has been doing so since September 2022, having bought back 2.9 million shares, nearly 4% of those in issue, and contributing 86 cents to a NAV of $50.47. The board has allocated $150m-$250m to a buyback pool, which JPMorgan estimates would add 2.9% to 5.2% to NAV at current prices. Are the shares illiquid? No, the market value of HVPE is £1,840m. Are costs high? Total expenses in the year were 1.8% of average NAV, of which one third was incurred in the underlying funds. Managing private equity is expensive, with costs more comparable to a listed company than to a fund investing in listed shares, but the returns are significantly higher.
HVPE invests via 63 funds managed by HarbourVest Partners and also in 16 co-investments. As a result, with 1,334 companies in the underlying portfolio, it is very well diversified. This means that there is little visibility of the underlying holdings, but the impact from individual problem companies will be very low. Investors appear to think the former matters more than the latter, but it is not obvious why. HVPE’s peer group of “fund-of-fund” private-equity trusts trades on an average discount to NAV of 35% (HVPE’s is the highest), with an average five-year return of 96% (HVPE’s is the second-highest). There are other private-equity trusts with better records than HVPE, but trading on a lower discount. There are some on higher discounts, but with terrible performance records.
James Glass of Numis Securities points out that
“in the UK, private equity... polarises opinion with a widespread view that it represents a culture of ‘greed is good’. As a result, benchmarks for personal, charitable and institutional investment have no allocation to it”. The UK’s aversion is both unique and irrational, given that “listed private equity consistently outperforms public equity, net of fees, by an average 6.25% per annum”.
Listed private equity provides investors access to an outperforming asset class that they could not access directly, with good liquidity at bargainbasement prices. Within a very undervalued sector, the combination of HVPE’s very strong performance record and inexplicably high discount is hard to beat – especially with the board trying to narrow the discount and add to NAV by buying back shares.