Market volatility, concerns around a trade war and worries over a slowing global economy have led to falls in markets during the latter half of 2018. Market sentiment has clearly changed since the summer. In the world of investment trusts this has led to discounts widening. The listed private equity sector has shared in this, but no-where has this de-rating been more heavily felt than in the fund of fund sub-sector. Discounts have widened considerably this year, but most especially from the position in May 2018. As the graph below shows, the average discount for the five fund of fund private equity trusts has widened by 9% since May.
Listed Private Equity Trusts: average discount changes
In the case of ICG Enterprise, the discount has widened from 9% in May 2018 to 21% at the end of December 2018 – yet the portfolio continues to perform and fundamentals of the drivers of ICG Enterprise’s returns remain unchanged. With an approach that has produced strong returns through the cycle, we take a closer look at the strategy, portfolio and benefits of the move to ICG three years ago.
The investment team believe the trust’s strategy provides shareholders with the “best of both worlds” in terms of having a relatively concentrated investment portfolio, with the diversification benefits of a third-party funds portfolio.
The managers choice of ICG as a home nearly three years ago is relevant at the current stage in the economic cycle. ICG’s flagship funds are aiming for private equity type returns, but with lower volatility. The team aims to increase what they term “high conviction” investments - co-investments and ICG originated deals - where they (or the wider ICG investment team) has made the investment decision to invest in the underlying company.
Indeed, the team have increased their deployment rate into co-investments to c. 2.5% of NAV per investment (versus c.1% whilst at Graphite). We expect the top 30 holdings to increase to perhaps 55-60% of NAV (currently 47%). Over the past 12 months 39% of all capital deployed has been invested in and alongside ICG as the team take advantage of the proprietary deal flow the trust now benefits from.
Given the backdrop of the past year or so, the team believe that a highly selective approach is key and remain cautious. As such, and across the portfolio and the recent investments, three themes dominate. The team have been investing in companies which in their view exhibit defensive growth (recurring revenue, quality earnings, barriers to entry), structural downside protection (including investing in the debt and equity of deals), and relative value (where deal dynamics has facilitated investment at very attractive valuations).
ICG Enterprise has delivered strong returns in the past and there is nothing to suggest strong earnings growth from the underlying companies shouldn’t continue to deliver strong NAV growth. We believe that the discount narrowing over the past two years has been a reflection of this strong performance, the favourable realisation environment and a growing awareness that the move to ICG has been transformational. Nothing in these fundamentals has changed, and as such, the discount widening back past 20% could represent something of an opportunity.
|Outperformance of public markets delivered over long term, through cycles
||Private equity valuations lag markets, so discounts may not be as wide as we think
|Move to ICG is steadily shifting the portfolio toward highly differentiated approach
||Gearing in underlying companies will magnify valuation movements
|Discount widened, and company buying back shares
||Sentiment towards risk assets and in particular LPE may remain tepid, meaning the discount may not narrow in the short term