Tapping into the potential of the US midmarket

Diversification may be the first rule of portfolio construction, but it can be a tricky target to hit.

Most of the major retail investing platforms provide investors with the tools to “look through” to the underlying investments that their funds and trusts hold. If you have made use of this functionality to examine your own portfolio, you may have been shocked by just how large an allocation to large-cap US equities you had without ever even realizing it. However, when you take a closer look atthe biggest ‘diversified global equity’ trusts, this becomes less surprising.

Four of the top five constituents of the AIC Global sector, between them the largest trusts on offer in the UK, have over 50% of their assets invested in the US (and this has come down since the 2021/22 sell off).¹

Yet, the typical allocation to the US within a global fund by no means reflects a full picture of its economy. Indeed, even US-focused listed equity funds tend to concentrate on the major indices, where market capitalisation is significantly larger than in other listed markets.

At the same time, the US economy currently provides a fascinating – and differentiated – context for businesses and investors. While Europe and the UK are still burdened with barely-improving inflation figures and stagnant growth, the US economy has begun to show some promising signals. Although it is still finely balanced, and could well tip into recession, the CPI of all-items fell to 6.4% in January this year and growth in the fourth quarter of 2022 surpassed expectations, with the economy expanding 2.7%.²

It makes sense that investors would seek exposure to this relatively optimistic picture within their portfolios. However, with many US listed companies generating much of their revenue globally, the impact of US revenues in large-cap equities is significantly diluted.

Caught up in the middle

Enter the US mid-market. The 200,000 or so businesses making up this segment are no minnows; indeed, they generate annual revenues of $10m-$1bn. According to Rothschild & Co they represent only around 3% of US businesses, and yet are responsible for a third of US GDP and employment.³  Crucially, they also proved resilient in the 2007-9 financial crisis.

However, getting access to these companies as an investor can be challenging, given that the vast majority are unlisted and increasingly delaying listing, as we have discussed previously. This is especially pertinent given that fewer than 15% of US businesses with revenues over $100m are publicly held, according to data compiled by US management consultancy Bain & Company.

For retail investors, listed private equity trusts could provide the solution. Some of these trusts, such as NB Private Equity Partners (NBPE), offer exposure to private companies in the US mid-market. This comes with added benefits, such as steering operational enhancement to drive value and a longer-term time horizon, that private equity investing can confer.

Private equity investors can be a game changer for mid-market businesses, providing much-needed financing to fuel growth in an environment where the traditional banking sector may be reluctant to step in. Private equity has long been the preferred partner for many of these mid-market companies, becoming valued long-term partners that provide strategic and operational expertise to guide growth, fueling the motivation of the mid-market to accept private equity involvement and ownership.

For private equity investors, the mid-market makes sense as a pool of opportunity. Acquisitions often attract somewhat lower valuation multiples than in the larger-cap sphere, and deals typically use less leverage, according to Rothschild & Co⁴. At the same time, fewer than 5% of mid-market companies currently have private equity backing.

An expert eye

NBPE itself has consistently maintained an allocation of between two-thirds and three-quarters to US companies. The portfolio is managed by Neuberger Berman, one of the most established private equity firms in the market with over 35 years as a private equity investor and employing over 290 private equity professionals globally.  

This established presence in the market and vast network of relationships provides access to a variety of private equity opportunities. NBPE invests through a co-investment approach that enables it to tap directly into these opportunities with ‘real time’ investment decisions, rather than by committing large amounts to third party funds which are drawn down over a long time (typically a number of years). This allows NBPE to be flexible with its investment decisions and pacing.

The trust invests primarily in EBITDA-positive companies with leading market positions, mission-critical products or services and sustainable business models. At the moment, the trust is invested in 93 companies alongside 56 different private equity managers, demonstrating the diversity of companies and underlying managers. The team has built the portfolio from the bottom up, focusing on resilient business models that the team believes will drive growth through the cycle.  

Mining the mid-market for growth

There are convincing reasons to seek exposure to the US economy at this moment in particular, yet actually achieving this comprehensively with a mainstream global or US equity allocation alone can be challenging. NBPE’s expertise, combined with the relative sense of optimism in the US mid-market, represents a differentiated investment proposition – gaining exposure to the US economy through a diversified portfolio of private companies, managed by some of the leading private equity firms in the world.

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