Fair shares for all

    4 November 2017

    At a recent gathering of the venerable Company of Merchant Adventurers of York, I listened to a sermon on the theme of ‘trust’ — the quality that enabled a flourishing trade in cloth between the medieval guild’s founders and Baltic merchants. But, as we all know, ‘trust’ in business today has been superseded by a culture that requires lawyers and reams of contract paperwork. Likewise, the trust that underpins share ownership by private investors has been severely eroded.

    According to figures from the Office for National Statistics up to 2015, the proportion of the population that owns shares has fallen from about 30 per cent in the heyday of Mrs Thatcher’s friend Sid — star of the British Gas privatisation campaign and herald of the ‘share-owning democracy’ — to less than 10 per cent today. Money managers abound who offer their clients in-house composite funds (and funds of funds) designed to ‘protect’ them from risks — but which, on account of their size and make-up, are very unlikely to perform better than the averages. So the client is discouraged from investing directly in for example, smaller AIM stocks that might require a modicum of research and judgment before buying; but is also ‘protected’ from the reward that’s the other side of the risk coin.

    So one unintended consequence of our non-trusting world has been to distance the private investor from a variety of equity investments — often the most lucrative. It’s not only AIM stocks; private equity funds are an asset class that historically have given better returns than publicly traded investments — as are Venture Capital Trusts, on which Jonathan Davis writes in this issue. Comparisons are bound to be debated, as returns depend on the average period an investment is kept within a fund and the size of each investment. But what is clear is that a professionally run private equity fund will do better over the long term than an equivalent portfolio of publicly traded shares. This should not be surprising, as the illiquidity implied in private equity requires an additional reward.

    Generally speaking, big infrastructure projects and high-risk-high-reward venture funds are the preserve of pension funds, sovereign wealth funds and other large capital pools. But the big battalions also have a grip on the breed of smaller listed growth companies that need constant injections of new capital. Very rarely is an open offer or a rights issue available to the small shareholder. Financings are usually arranged quietly between large institutions and often desperate companies at a significant discount to the prevailing market price — and not entirely without justification, since the costs and time required to produce the necessary documentation and tick the compliance boxes for a more public capital-raising can be critical for a small company on the edge. Once more, the smaller shareholder is at a disadvantage.

    So my task here is to look for ways in which a small investor can at least share a level playing field with the institutional investors, through private equity funds and shares. A preliminary and obvious caveat is that the growth companies in private equity portfolios will always take time to flourish — and many will fail. So the smaller investor must also be patient enough to share the long-term perspective of the institutions, and must remember that ‘past returns may not be an indicator of future ones’.

    Bear in mind also that fee structures within such investment vehicles will always give the richest rewards to their managers rather than investors. But, with all those caveats, here are half a dozen names readers might care to consider as ways into the exciting world of private equity.
    3i GROUP
    Share price £9.46;
    Market cap £9.2bn
    3i is the ‘daddy’ of this sector. It’s nearly as big as the next 20 London-quoted private equity funds put together and is the most venerable, tracing its origins to 1945. Then as now, there was a perceived problem in matching the financial needs of small and medium-sized enterprises with existing capital markets. So, with government help, the major UK banks came together to create the Industrial and Commercial Finance Corporation, which was later rebranded as Investors in Industry then floated in 1994 with the catchier name of 3i Group.

    3i invests in private equity throughout the world and has a listed spin-off, 3i Infrastructure, which it advises and with which it sometimes co-invests. The latter’s price (£1.97) has hardly moved since it was mentioned here in February 2017. Infrastructure is a long-term game; patience is required, but in the same time the price of 3i itself has improved by nearly 30 per cent, outperforming most equity markets. This being the case, we’re left wondering if the defensive qualities of a large portfolio of international long-term investments will continue to serve the investor so well when the inevitable downturn comes along.
    71p; £75m
    This is one of four publicly traded closed-end trusts that are managed by NVM Ltd, a well-respected Newcastle-based firm that was started in 1988 and has supported more than 300 small companies and returned £500 million to shareholders to date.

    The four trusts tend to co-invest in the same companies and all three are presently raising additional capital of £20 million each. The tax advantages agreed by the Inland Revenue can only be earned by keeping shares for five years. Nonetheless, liquidity is provided by both the stock market and the fact that each entity has a buy-back scheme. All three companies return capital to their shareholders through a mixture of annual dividends and capital repayment following a sale of an investment — both tax-free. Once more, the patient investor should be encouraged by the track record of the management team and consoled by a steady tax-free dividend stream. One for serious consideration?
    £3.50; £535m
    Here is another stellar performer, whose shares have appreciated 30 per cent this year. But with a long-term portfolio that includes infrastructure projects, rolling stock for Bombardier trains on the South Western franchise and private equity deals throughout Europe, there is surely more growth in store. Valuing the assets of such funds is always a stab in the dark, but managers and auditors are likely to err on the cautious side for obvious reasons. So the published NAV per share of £4.00 as at the end of August suggests the share price could yet improve. While waiting, a recently announced dividend of 12p is a consolation.
    £18.29; £700m
    This company has shown one of the best performances in its sector — an annual return of 13 per cent over the last ten years — but is changing its corporate structure to let the management team take a more active role in its underlying investments. Part of that change involved returning more than £2 billion to shareholders. Needless to say, the share price reflects this, having fallen from a high in April of about £51. Last week, the company announced a further £9.14 per share dividend leaving assets and cash worth £11.14 per share. The new structure will also reduce management charges by more than £28 million annually. The fact that Witan Investment Trust bought a further 1.6 million shares not long ago should provide comfort to private shareholders. Selling at a discount to the residual asset value (which might well be upgraded at the end of the year), the shares are a low-risk gamble on a proven management team embarking on a more hands-on approach to private equity financing than in the past.
    £17.45; £651m
    It took me some time before realising that this company’s name gave a hint as to its origins. If I mention Warburgs and that a knowledge of chemical symbols might help, the riddle should be solved. But the real point is that its managers have been around long enough to learn a few tricks. In particular the company has been an early investor in renewables throughout Europe, including small hydro schemes.

    Net assets have grown by 63 per cent over the last three years, putting it among the top four in the sector. With offices in London and Munich, Hg is well placed to get close to private growth companies throughout Europe — especially in its specialist areas of technology, media, telecoms and renewables. The Hg Group that manages HgCapital Trust has about £5 billion of private company and infrastructure funds under management: hence investors can enjoy the benefits of a large organisation with specialists in all areas. On that basis, the annual management fee of 1.4 per cent seems good value.

    With an asset value of £18 per share, the discount at £17 is not as large as some. Nonetheless, for those prepared to take the usual longer view and wanting a spread of private equity investments throughout Europe, this is a high-quality choice. 
    £1.00; £55m
    And now for something different. Downing takes the view that it is not just the private equity market that small investors can miss out on. The trust has noticed that — as I mentioned in my introductory remarks — small public companies are often forced into emergency financings that are the preserve of institutions only. It is also the case that most brokers cannot afford to research the smaller companies and so private investors are left to their own devices. Last May, Downing Group floated its Strategic MicroCap fund with £54 million of new funds to be invested in companies worth less than £150 million.

    The NAV is 95p, so the current premium, though small, needs to be justified. So far Downing has provided loans of £7.5 million to Real Food, and bought shares totalling £14 million in a portfolio including Redhall Group (a classic recovery stock mentioned here in February), Adept Telecom, Braemar Shipping, and Gama Aviation. With nearly £30 million left in cash, Downing is clearly anticipating a downturn in the market and keeping its powder dry. Some of us think it could be right.