Many investors still ignore private equity having been burnt during the financial crisis. In the listed space, even the highest quality funds saw their discounts to net asset value explode, often to as much as 80 per cent, on concerns over leverage and unfunded commitments.
However, much like public equity markets, the NAVs of the better trusts experienced a V-shaped recovery and the underlying companies quickly returned to profitability. The discounts nevertheless stayed stubbornly wide.
We would expect private equity trusts, with their inherent underlying illiquidity and infrequent valuations, to trade at a discount but current double-digit discounts look overdone. Crucially, it is a great environment for realisations.
Companies have unprecedented amounts of cash on their balance sheets and M&A activity has noticeably picked up. We currently favour relatively mature funds biased towards exiting investments rather than putting new cash to work, particularly in those parts of the world where valuations are looking a bit stretched. Our top picks are Pantheon and Standard Life European.
The renewable energy sector has hit critical mass over the past two years with the launch of six trusts focusing on wind and solar assets. There are several clear reasons why these vehicles appeal to investors: they pay attractive yields of 5 to 6 per cent, they have visible, long-term earnings streams underpinned by government subsidies and while valuations are sensitive to inflation and long-term interest rate expectations the variation in earnings is mainly a function of weather patterns and power prices, not the business cycle, which has attractive diversification benefits.
Renewables have been stress tested in recent months, mainly over misconceptions linking falling oil prices to volatility in power prices, but proved reassuringly resilient. We also believe changes to the subsidy structure are, on balance, beneficial to the owners and operators we are backing. Our favoured holdings in the space are The Renewables Infrastructure Group and Foresight Solar.
Fixed income has been the bane of most multi-asset managers’ lives for the past eight years. Yields have gone from low to negative, wrong-footing any asset allocator with valuation as part of their investment criteria. Bond investors have been forced to take on more credit and liquidity risk to generate a bit of return.
For some, that means buying CCC/CAA-rated junk bonds (with an historic five-year cumulative default rate in excess of 30 per cent, according to Moodys). We would rather the odds were less stacked against us and, away from the mainstream fixed income markets, there are some areas of genuine interest.
A theme we are playing is that of bank retrenchment, which has left the field open for specialist lenders. Property is a good example of a sector where many high quality but smaller companies are starved of credit because banks will not lend to them due to capital ratio requirements. We like these relatively low leverage, asset-backed loans that still offer high single-digit yields. Real Estate Credit Investments Ltd, for example, has been a great investment for us.
James de Bunsen is multi-asset fund manager at Henderson