Standard Life Private Equity (SLPE) is a private equity fund of funds and is the only such trust with no performance fee. SLPE invests in a high conviction portfolio of third party private equity funds. At any one time, the Trust is investing through about a dozen core managers and currently the top ten managers’ investments constitute 66% of NAV.
At the start of 2017, the company started to increase exposure to North America by broadening its investment criteria to include US domestic funds The team expects exposure to gradually increase, as well as continuing to target secondary investments to take advantage of attractive investment opportunities and help reduce cash drag.
In common with peers, realisations from the portfolio have been coming in steadily. SLPE currently has c.13.5% of NAV in cash which the Manager is happy with, giving it the flexibility to be opportunistic if market conditions deteriorate. The company runs an “over-commitment” strategy to try to maintain investment levels. Its long-term target range is 30-75%, and as at 30th September 2018 we calculate that the level was 35% - which is in the target range – considerably up on the September 2017 figure of 24.5%.
Last year and this, the manager has been trying to place more emphasis on buying fund interests in the secondary market, which can be used to increase the company’s exposure to attractive funds without adding significantly to outstanding commitments. It has been actively bidding on deals, but reports a very competitive backdrop. A successful transaction would likely absorb a significant amount of cash, and quickly transform the invested position of the company.
Since inception in 2001 to 31st July 2018, SLPE has delivered an annualised NAV total return of 9.6% relative to the FTSE All-Share Index's annualised total return of 6.0% - representing strong outperformance against quoted markets. Indeed, the underlying portfolio returns will have been higher than this, given cash drag over the years and the fact that until 2016 the manager was paid a performance fee. Over the past five years, SLPE is well ahead of quoted markets, driven by strong realisations at material uplifts.
The board is targeting a dividend of 12.4p per share, equivalent to a yield of approx. 3.7% on the current share price. Going forward, the board intends to grow the dividend at least in line with inflation and has moved to pay quarterly dividends, further enhancing the attractiveness of the trust to income investors.
SLPE currently trades at a discount of c 16%, in line with the peer group average.
SLPE invests in a high conviction portfolio of third party private equity funds. At any one time, the trust is investing through about a dozen core managers, which means that over a longer time frame, there are around 35-40 “active” fund investments. The top ten managers currently constitute 66% of NAV. Their approach ensures that the portfolio is diversified by manager and by underlying investment. In contrast to peers, the team does not participate in co-investments offered to them, although does have an active programme of sourcing and investing in secondary investments of third party funds that they prefer. Indeed, such has been the extent of the realisations coming through from the portfolio, the team has been trying hard to put more money to work through secondaries. If successful, this has several advantages, not least in that it gets capital to work quicker, but also that it means there is less of an associated outstanding commitment.
At the current time, the portfolio’s largest holding by a long way is in Action (7.2% of NAV at 31st March), held through a 3i fund – which is widely regarded as one of the very best private equity investments made in recent years. Aside from that, it is well diversified by sector and size of company. When we met with members of the manager’s investment team recently, they explained that they are reacting to the currently “hot” private equity market by focusing on managers who have a distinct edge or niche. For example, over the summer SLPE made its first commitment to InvestIndustrial Growth, which is a new strategy for the team targeting smaller, lower mid-market growth opportunities. This new relationship is to some extent a result of the Aberdeen and Standard Life merger. The team’s new colleagues from Aberdeen have a longer standing relationship with InvestIndustrial, having generated strong returns for them in the past. Similarly, the team has made a commitment to Triton V, which has an operating focus in the Nordic region specialising in industrial turnarounds and more complex situations.
In this way, the team hopes that the company will continue to find its way into interesting and profitable opportunities, and not get caught up in the more competitive areas of the private equity market. Certainly the managers the team is looking to make new commitments to need to show they have a differentiated approach, and operational expertise that can add value in more difficult stages of the economic cycle.
The company continues to broaden its remit from being primarily European focused towards increasing exposure to leading North American private equity funds. The team has made a new commitment to Atlanta-based MSouth IV, and bought a secondary investment in Onex. The current exposure to North America is 15% of NAV, and expected to rise modestly as a result of these as well as other opportunities that the team is currently considering.
Source: SL Capital Partners
So far this year, the Trust has had some successful realisations, one of the more significant being Scandlines which was the company’s second largest holding. The company was sold at an 83% uplift to the valuation two quarters prior. Overall, this investment has generated a return of 7.0x cost. Other strong contributions to performance have been Atrium (exited for 2.7x cost), E. Winkemann (exited for 3.6x cost) and Convatec (exited for 3.0x cost).
In common with the other constituents of the Listed Private Equity (LPE) sector, and as we discuss in the gearing / cash management section below, proceeds from realisations have been strong – faster than the underlying managers have been deploying capital. In the most recently announced NAV and factsheet as at 30 September 2018, cash on the balance sheet was £86.5m, representing 13.5% of NAV.
Overall the manager reports being comfortable with this level of cash given the point in the cycle and the desire to be able to take advantage of any opportunities should there be a market dislocation. However, the manager is also taking advantage of the secondaries market and is looking for this proportion of the portfolio to rise from the current level of 17%. Progress on this front has been hampered (for the moment) by the very competitive market for secondary interests, but the situation could change quite rapidly given the size of transactions that they are bidding for.
In terms of underlying diversification, the top ten underlying holdings represent 17.6% of the portfolio. In total, the manager estimates that the trust has investments in c. 350 companies (excluding some legacy secondary fund investments). As with the other comparable peers, the trust has a broad spread of exposures to sectors (see below) and “vintages”. Only 24% of the portfolio is in deals older than five years, meaning significant amounts of capital have been put to work during the more recent relatively benign investment environment, which should be the engine of NAV growth for the next few years. Realisations from the older vintages will continue to provide the cash flow for the “over-commitment” strategy – covered in the gearing section below.
SECTOR BREAKDOWN AS AT 31st March 2018
Gearing / Cash Management
As at the end of September 2018, the trust has c 13.5% cash on the balance sheet and has an unutilised revolving credit facility of £80m, which expires on 31 December 2020. When we spoke to the manager recently, the team reported that they are happy with the current cash position and that with the current uncertain market environment, they feel now is a good time to have capital to deploy opportunistically.
The trust runs an “over-commitment” strategy to try to maintain investment levels. The manager measures this as outstanding commitments, less cash and gearing facilities, as a percent of NAV. Its long-term target range is 30-75%, and as at 30 September 2018 we calculate that the level was 35% - which is in the target range – and considerably up since the September 2017 figure of 24.5% as the graph below shows. This is far from the more extreme levels of 2007 and 2008.
Over – COMMITMENT Ratio OVER TIME
Last year and this, the manager has been trying to place more emphasis on buying fund interests in the secondary market, which can be used to increase the company’s exposure to attractive funds without adding significantly to outstanding commitments. It has been actively bidding on deals, but reports a very competitive backdrop. A successful transaction would likely absorb a significant amount of cash, and quickly transform the cash position of the company. SLPE’s commitment-cover (representing cash and gearing, divided by uncalled commitments) is currently estimated by JPMorgan Cazenove at 0.4x which is slightly more aggressive than the average of the FoF peers (excluding JPEL Private Equity) average of 0.5x.
Since inception in 2001 to 31 July 2018, SLPE has delivered an annualised NAV total return of 9.6% relative to the FTSE All-Share Index's annualised total return of 6.0% - representing strong outperformance against quoted markets. Indeed, the underlying portfolio returns will have been higher than this, given cash drag over the years and the fact that until 2016 the managers were paid a performance fee.
More recently, over the past five years, SLPE is well ahead of quoted markets, as demonstrated by the chart below. The trust remains in line with performance of the fund of fund peer group. We understand that the strong level of realisations at material uplifts has been the main driver of returns. The managers comment that they continue to see, on average, c. 25% uplifts to valuations when portfolio companies are exited.
SLPE NAV RETURNS AGAINST Quoted markets and peers
As we demonstrate in the graph below, whilst performance during 2012 and 2013 was weak relative the index, NAV performance has bettered the comparable indices in each calendar year since then. The impact of Sterling weakness relative to the Euro and Dollar was a significant tailwind during 2016. But performance in 2017 has been strong, and so far this year has also been ahead of equity markets.
DISCRETE ANNUAL RETURNS
As we touch on above, SLPE has performed strongly relative to peers, and in recent months has benefited on a relative basis from HarbourVest and Pantheon suffering from dollar weakness. ICG Enterprise, F&C Private Equity and SLPE have similar exposures to Europe and have all performed broadly in line with each other over the past five years, but this masks a much stronger recent performance that the trust has delivered in the past four years relative to equity markets.
In common with many of the listed private equity sector funds, the board pays an enhanced dividend (roughly 2/3rds from income, and 1/3rd from capital) designed to broaden the appeal of the trust to investors. At the last interims (Mar 18), the board stated its expectation that the full year dividend would equate to 12.4p, representing a yield of 3.7% at the current share price. The board sets the dividend each year with reference to the year end NAV and the ambition to pay a dividend equivalent to a “yield of approximately 3% on NAV per ordinary share” as at that date. In addition, it has stated that it is committed to maintain “the real value of this new enhanced dividend and growing it at least in line with inflation, in the absence of unforeseen circumstances”.
As we shall see below, the enhanced dividend - first announced in 2016 - has had something of an impact on the discount. As the graph shows, this represented a material increase in the dividend compared to what investors experienced historically.
As we have discussed before, within the listed private equity sector, there has been considerable manager risk from investing with a single underlying manager. This has meant that over the last five years, the average fund of funds has outperformed the average direct investing trust.
PEER GROUP NAV RETURNS
SLPE has a more concentrated portfolio relative to Pantheon or HarbourVest’s very diversified funds, although slightly less concentrated when compared to fund of funds such as ICG Enterprise and F&C Private Equity. However, within the fund of fund peer group, Standard Life Private Equity has similar geographic exposures ICG Enterprise, and F&C Private Equity, but a much lower exposure to the US than Harbourvest and Pantheon. It also has the simplest fee arrangements, with no performance fees payable to the manager since 2016 – unique amongst its peers.
SLPE’s commitment-cover is slightly more aggressive than peers - estimated by JPMorgan Cazenove at 0.4x relative to the average of the FoF peers (excluding JPEL Private Equity) of 0.5x.
The trust is managed by SL Capital Partners ("SL Capital"), part of Aberdeen Standard Investment. The team is led by Merrick McKay, who leverages the extensive investment team with experience across Europe, the US and Asia which has been responsible for running and investing for the trust since its launch in 2001. When we spoke to the manager’s team members recently, they noted that the heritage Standard Life and Aberdeen colleagues had been working together in the same offices for over a year now.The integration was very complementary, given they now had good exposure to colleagues with expertise in Asia and the US. As such, the manager now sees itself very much as a global private equity team, with around 50 investment professionals around the world.
Aside from SLPE, the Aberdeen Standard Investments' private equity team currently manages around £13bn of private equity assets on behalf of institutional clients around the globe. The team believes that, as one of the leading investors in private equity funds in Europe and North America, their extensive fund experience (a track record of >1,000 fund investments) gives it greater insight into the strategies, processes and disciplines of the funds in which the trust is invested and allows it to make better qualitative judgements.
As the graph below shows, SLPE’s discount has narrowed significantly from levels reached in 2016. That said, progress over the past year or so has been harder fought – which has been shared by the entire sector. At the time of writing SLPE trades at a discount of c 16% according to Numis estimates, which is in-line with the fund of funds peer group average, but clearly remains wider than the broader investment trust peer group.
The board does not have a formal share buyback or discount control policy, but has bought shares back opportunistically in the past at what it sees as attractive levels to support the share price. For example, in the financial year to September 2016, the board spent c. £5m buying back shares on an average discount of around 30%. The board has not bought shares back since August 2016.
Private Equity is a very engaged business and so “direct” PE managers usually charge a management fee in the order of 1.5% per annum on commitments and a performance fee of 20% over a hurdle of 8% realised total returns. It is fair to assume that this fee is being charged on average on underlying private equity funds in SLPE's portfolio. At a fund level, the management fee payable to the manager is 0.95% on net assets, which is in line with the FoF LPE funds, although we note that there is no performance fee attached - a unique feature in the FoF peer group, making it one of the more cost-effective options for investors to access private equity investments. Indeed, the OCF excluding performance fees (calculated along AIC guidelines) was 1.13% at 31 March 18, compared to the average for the fund of fund sub-sector of 1.47%.
The KID cost, incorporating all underlying fees and performance fees is 5.95%. The level reflects the fund of fund model (and is broadly in line with similar fund of fund strategies like ICG) incorporating underlying fund performance fees. Since underlying fund performance has been strong in recent years, these performance fees have been higher than the long-run average.