Scrutineer: How trusts fell victim in a private equity disaster

Published on Sunday 21 June 2009 21:42

ONE of the most promising areas for investment trusts ahead of the global credit crisis was private equity.

However, even allowing for the greater risk involved in specialist funds of this sort, the past year has been an unmitigated disaster for the private equity sector and the trusts that invested in it. Prices have collapsed (where valuations could be trusted at all), deal flow has slumped and anxious bankers have called in their loans. The result? Catastrophe.

Aberdeen Development Capital has suffered a 62 per cent share price collapse over the year to last Friday, and the fall over five years is even worse at 77 per cent. F&C Private Equity has fared little better, losing 53.5 per cent over one year and almost 60 per cent over five.

Standard Life European Private Equity, once one of the biggest funds in the sector, saw its shares collapse from 166p to just 30p at one point. Today, even after a sharp recovery in recent weeks, the shares at 101p are still barely half their level a year ago, and stand on a discount to underlying assets of 40 per cent – a measure of the market's deep uncertainty on the robustness of valuations.

The explanation in the latest interim report for the six months to the end of March is, I am afraid, as lamentable as the fund's performance.

A bloodied and painful retreat seems to be the main theme. The trust has sold down four of its original commitments for 15.1 million compared with a recent aggregate valuation of 38.9m.

The trust has also sold down its holding in another fund, CVC Europe V, to realise just 100,000 compared with a valuation of this stake at 1.3m. Little wonder the discount is as wide as it is.

The statement from chairman Scott Dobbie offers little by way of clarity. While much of the movement in European private equity valuations in the interim period has been driven by a fall in comparable listed valuation multiples, "the key variables going forward are expected to be underlying profitability and covenant headroom within existing debt structures".

Investors are surely entitled to a little more candour than this, and I hope the annual report will see a better effort.

Hamish Mair, manager of F&C's 155m private equity trust gave a detailed analysis of the fund's risk profile and a robust defence of the fund of funds approach at the Association of Investment Companies roadshow in Scotland earlier this month.

He sees opportunity in the mid-market sector – companies of between 50m and 500m in size where F&C has expertise, rather than the top end where there is still capital overhang.

I have included in the table the 850m Caledonia Investment Trust. It is not strictly a private equity fund, although some 20 per cent of the portfolio is in unquoted securities and a further 17 per cent in hedge funds. Its biggest quoted plays include a 20m holding in Irn-Bru maker, AG Barr.

Caledonia's share fall over the past year has been limited to 21 per cent, due in large part to shrewd use of FTSE put options which brought a gross return of 25m, thus mitigating losses on holdings in private companies. It has maintained its record of dividend increases and has some 50m available for investment.

Despite this appalling year – and to a small extent because of it – the unquoted sector offers our best hope for recovery and investors should have some exposure to it.

I would say the first stop choice in investment trusts is Caledonia for its quality of management, adroit holdings in quoted companies, portfolio spread and track record. It offers a more balanced risk. It has also been, and remains, a great investment trust.

&#149 Last week's reference to Sebastian Troy of Troy Asset Management should of course have read Sebastian Lyon. My apologies.