With the shares of many private equity trusts trading at huge discounts, is now the time to strike?

The word ‘discount’ is one of the most alluring words in the English language.

But in the case of private equity investment trusts, the cuts are currently arousing more suspicion than excitement.

The share prices of many of these trusts – which back the unlisted companies poised to become the stars of tomorrow – are at a massive discount of as much as 40 percent to their net asset value (NAV).

These trusts can provide useful exposure to fast-growing companies – in financial services, retail and technology in the UK, US and Europe.

But the discounts are so deep that many conclude that private equity trusts are cheap for a reason, and not one of the best buys of fall 2024.

Such is the level of distrust that some are even looking askance at the industry’s only trust, which commands a huge 56 percent premium to its share price – and has delivered a 1,070 percent return over the past decade.

This is 3i Group, a FTSE 100 company founded in the post-war period as Investors in Industry.

Today the £32 billion trust is best known for its 58 per cent stake in Action, the supermarket chain with 2,725 outlets in 12 European countries.

But is the gap in our understanding of these trusts as wide as some discounts? Ben Yearsley of Fairview Investing argues that there is a ‘disconnect’ between reality and market perception. “Over the long term, these have been very good investments to own, even if you have to buy them for a decade or so,” he says.

Charlotte Morris, co-manager of the Pantheon International Partners trust, emphasizes the breadth of options available.

“We put money into growth-oriented companies operating in defensive, non-cyclical sectors, which benefit from long-term trends such as aging, automation, digitalization and sustainability,” she said.

Pantheon’s portfolio includes companies such as Smile Doctors, a growing American orthodontics chain Altamont Capital Partners and a small part of Action shares. If you prefer to be bold when others are afraid, you may be intrigued by the opportunity for diversification that private equity trusts offer, especially after reforms to fee disclosure rules that made their fees seem prohibitively high.

In addition, private equity trust-favored companies looking for financing should get a boost from further downward moves in interest rates. The high borrowing costs are one of the reasons for the size of the discounts.

But you must be prepared for a journey into unknown territory.

Very few of these trusts’ investments have names you’ll recognize, although the £1.7 billion HarbourVest Global Private Equity (HPVE) has a small piece of Shein, the controversial Chinese fashion giant, which is reportedly ready for an IPO of £50 billion in London.

HPVE, the second largest trust in the sector, is at a 43 per cent discount, down from 52 per cent in March last year. But while most companies backed by private equity trusts may be shady, they’re not necessarily struggling.

James Carthew of analytics group QuotedData points to figures from MSCI Burgiss showing that profits from management buyouts have grown faster than those of the average listed company in nine of the past ten years.

One reason for the extension of discounts is the belief that trusts are overly optimistic about the valuations of their investments, leading to disappointment when these holdings are sold or seek a stock exchange listing.

Analysts disagree.

Carthew says: ‘In general, valuations in the sector are conservative.’

Stifel’s Iain Scouller added: ‘We expect turnover from companies in these trusts’ portfolios to pick up in the coming year.

‘When an investment is sold, a gain of 20 to 30 per cent above its previous valuation is typically achieved – resulting in an increase in the trust’s intrinsic value.’

Nevertheless, questions about valuations are likely to remain. The ShadowFall hedge fund, led by Matthew Earl, aka ‘the Dark Destroyer’, is shorting 3i shares because the trust has too rosy a view of Action. The £14.8 billion stake makes up 72 percent of the portfolio. Earl claims that 3i values ​​the chain at 18.5 times earnings, compared to the average of 14.4 times for this type of retailer.

The Dark Destroyer’s assessment is of course disputed, with some praising Action’s power and prospects.

Carthew points out that ShadowFall’s claims are ‘contrary to all evidence of Action’s impressive growth record’.

But he wonders whether 3i should consider realizing its stake in the chain by handing out some cash to shareholders and looking for other companies that could be primed for greatness.

After all, 3i’s Action piece is worth 120 times more than when the trust first saw the chain’s potential in 2011.

The row over Action will continue, although there will be significant interest in the future sale of 3i’s majority stake in pet food group MPM, maker of brands such as Applaws for cats.

Meanwhile, analysts are still predicting a further rise in the trust’s shares, from the current 3300p to 3500p. This is comparable to 1993p in November last year, when 3i appeared in this column.

At the time, I followed my own advice and put some money into shares of this trust. I stay on board because the argument about Action’s value seems to have entertainment value.

The picks of industry experts include Hg Capital, Europe’s largest investor in software companies. There is a 2.5 percent discount on this trust, which favors companies whose executives have put some of their own money into the business. The shares are at 518p. The average analyst target is 540p.

Yearsley likes Pantheon, at a 34 percent discount. The shares are trading at 318.5p, but analysts are predicting a rise to an average of 395p.

He is also a fan of NB Private Equity, with a 25 percent discount. This trust owns a small piece of the popular retailer Action, but focuses mainly on the US. The average analyst price target for the shares – currently trading at 1532p – is 2374p.

Carthew names Oakley Capital Investments as one of his favorites. The trust, whose discount is 30%, focuses on consumer digital businesses, education and technology and has grabbed some bargains in these sectors in recent years. Shares are up 10 cents to 500 cents year to date. But analysts are targeting a rise to 656p.

BestInvest’s Jason Hollands thinks HarbourVest Global Private Equity has the potential to deliver strong returns.

The current share price of the trust, which employs several teams of managers to find the best deals, is 2335p, but analysts have set a target of 3796p.

Some of this optimism will likely stem from the belief in some quarters that the discount is ridiculously large – and that the markets will realize this and have a change of heart.

The prospects for these and other private equity trusts are undoubtedly better than before, with more stakes likely to be sold at decent prices.

There is no timetable for limiting the discounts. But while you wait, support growing companies and act as a venture capitalist from the comfort of your home.

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