“Hands-on, long-term approach”: Private equity managers defend sector against recent criticism
Morrisons is the latest well-known UK business to announce a potential sale to private equity following others such as the AA earlier in the year. Last year there were 25 take-private deals with a total value of GBP21.1 billion, according to professional services firm BDO.
Private equity’s interest in public markets has awakened some long-standing criticisms of the sector, but are these justified? What are the benefits of private equity ownership to businesses and how are private equity investment companies taking ESG factors into account? The Association of Investment Companies (AIC) has invited comments on these issues from investment company managers in the Private Equity, Growth Capital and Biotechnology & Healthcare sectors.
Are criticisms of private equity justified?
Helen Steers, Partner at Pantheon, manager of Pantheon International Plc (PIP), says: “In general the reality of private equity investment is a far cry from the image that is sometimes portrayed in the media. The private equity managers that we back take a hands-on, long-term approach with their investee businesses, working with the companies’ management teams to grow their businesses, and providing them with key operational and strategic expertise. They help those businesses to improve in many areas such as sales and marketing; digitalisation; researching and developing new product lines or services; enhancing supply chains and procurement processes; finance and optimising the capital structure; strengthening management itself; and building scale through M&A and/or by expanding into new geographies.”
Richard Hickman, Director of Investment and Operations for HarbourVest Global Private Equity, says: “Some media outlets have focused predominantly on the negative private equity stories, without balancing these with more positive case studies. As a fund of funds investing into HarbourVest Partners’ funds, we rely on HarbourVest to select the private equity managers it believes can bring out companies’ full potential. A core component of the asset class is endeavouring to drive genuine operational improvements at investee companies to create value; the experts in the private equity firms often supplement their own efforts with the advice from sector specialists who complement this process. Ultimately it is in nobody’s interest for a company to fail.”
Oliver Gardey, Head of Private Equity Fund Investments at ICG, the manager of ICG Enterprise Trust, says: “We only partner with private equity managers who share our desire to invest in profitable, cash generative businesses which have a strong track record of revenue growth which in turn leads to job creation. This is supported by recent data: a recent survey by Invest Europe suggests that Europe’s private equity-owned firms have created jobs five times faster than the European average. The companies also benefit from the experience and operational resources of our managers – a key element of value creation is making companies better through investment in manufacturing infrastructure, digitalisation and technology, and through greater investment in people.”
Richard Watts, Co-Portfolio Manager of Chrysalis Investments, says: “We don’t simply invest, we collaborate. We bring our experience, knowledge and network to entrepreneurs, developing strong relationships with management teams as we back them with permanent capital. We purposefully launched a vehicle that would enable us to take a long-term approach where we are not influenced or constrained by the life of fund, as a typical LP fund can be.”
ESG in private equity
Gardey says: “For our direct and ICG investments, we use a proprietary ESG screening checklist to identify potential ESG risks by industry sector and geography. The checklist utilises various data sources, including the Task Force on Climate-related Financial Disclosures, the Sustainability Accounting Standards Board, ThinkHazard, Climate Change Performance Index and the World Bank Carbon Pricing Dashboard. For investments via third party funds, we seek to partner with managers who share a similar approach to ESG.”
Steers says: “The application of sound ESG principles is a core part of how we make investments on behalf of PIP. Pantheon was one of the first private equity signatories to the UN Principles for Responsible Investment in 2007 and we apply them right from when we are first assessing an investment all the way through to divesture. When considering a new investment opportunity, we conduct a detailed ESG risk assessment on the private equity manager or co-investment deal as part of our due diligence. It doesn’t end there. Once an investment has been made we continue, through the use of the RepRisk tool, to monitor the companies in PIP’s underlying portfolio for any ESG-related issues. If we identify any issues, we will contact the private equity manager concerned to find out more about the issue and what action has been – or will be – taken. We are also able to use our position on over 470 fund advisory boards to raise standards and influence the ESG and diversity and inclusion policies and approach of our private equity managers.”
Nick Williamson, Co-Portfolio Manager of Chrysalis Investments, says: “We have aligned our strategy, purpose and principles with the UN Global Compact (UNGC) such that all investment decision-making and engagement is guided by the principles of the UNGC. This means investee companies are expected to abide by the Compact’s Ten Principles, committing to meeting fundamental responsibilities in the areas of human rights, labour, environment, and anti-corruption. As part of the due diligence process, we look to identify how sophisticated and proactive companies are in these areas. While post-investment we aim to help companies implement policies and procedures that will enable them to excel from an ESG perspective and we actively monitor the progress made.”
Private equity investment company discounts “anomalous” and “unwarranted”
Gardey says: “We view the discounts as being anomalous given the track record of strong performance. One of the possible reasons for the discount is there is a relatively small pool of actively engaged investors compared to other asset classes. We would like to broaden the appeal of the sector as we believe that private portfolios in the UK are under-allocated to private equity. Many of the world’s most sophisticated investors – including multi-billion dollar endowments and sovereign wealth funds – have been increasing their allocation to private equity. Investors who do not have an allocation to private equity are missing out on the long-term value opportunity. Listed vehicles democratise the asset class, giving individuals and smaller organisations access to private equity. The listed private equity sector, including ICG Enterprise Trust, has consistently outperformed a range of broad range market indices.”
Steers says: “We do not understand the discounts in the private equity investment company sector and, in our view, they are unwarranted. If we look at PIP, for example, it has delivered 11.8 per cent average annual NAV growth since the company was founded over 33 years ago and the average uplifts achieved by our private equity managers when selling the underlying companies was 20 per cent for the six months to 30 November 2020. In addition, the companies in our portfolio delivered much stronger revenue and earnings growth compared to the companies in the MSCI World index. We believe that this demonstrates the embedded value in PIP’s portfolio and the ability of our managers to invest well and create value in their investee companies during their ownership.”
Hickman says: “Unfortunately, an image problem seems to persist, with some of this still stemming from the global financial crisis, when some listed private equity firms ran into balance sheet trouble. Today, balance sheets are stronger and private equity investment companies are tapping into some of the most exciting, investable opportunities available in private markets. Most listed private equity firms are specialists who have been doing this for a very long time – it’s their bread and butter – and while several new entrants are honing in on unlisted opportunities and trading at premiums, the share prices of the ‘old guard’ continues to lag as investors focus on these new offerings.”
Best unquoted opportunities: technology and healthcare
Stephanie Sirota, Chief Business Officer at RTW Investments and Director at RTW Venture Fund, says: “In the last half dozen years, the industry has doubled the number of viable treatment modalities to target disease. In vivo gene editing is the latest treatment modality to emerge. RTW is excited about innovation across the sector, but some areas worth mentioning are rare genetic disorders, neurological and psychiatric disorders, cardiovascular and eye diseases.”
Steers says: “PIP’s portfolio is tilted towards information technology, healthcare and consumer staples. These sectors have shown remarkable resilience through the Covid-19 crisis and some sub-sectors have benefited from the trends that have been accelerated by the pandemic such as remote working, the shift to e-commerce and lifestyle changes as people take more interest in their own health and wellbeing. We continue to see exciting opportunities in these sectors in our deal pipeline.”
Watts says: “Fundamentally, Chrysalis is looking to identify later-stage assets that operate in huge addressable markets that are benefitting from structural tailwinds. We have identified assets across a variety of sectors including: Financial Services, Insurance, Media, Technology and Retail. These sectors are all currently being disrupted through digitisation and we are looking to uncover the disruptors.”
Biggest private equity risks: liquidity and maturity
Gardey says: “The two most obvious risks are liquidity and governance: how can you turn your investment into cash if you need to, and how do you ensure strong governance outside of the more formal rules for listed companies? Liquidity is one of the most attractive features of listed private equity: although the underlying assets in our portfolio are privately owned and generate private equity returns, our shares are traded on the London Stock Exchange. Being a closed-ended fund, our shareholders’ ability to buy and sell shares is entirely disconnected from the pace at which we buy and sell assets. As a manager, we of course look at liquidity very seriously: we ensure we have a robust balance sheet and an appropriate level of commitments and investments to enable us to manage our portfolio for long-term growth.”
Hickman says: “There are risks with any investment, and different levels of risk within unquoted companies – for example, backing early stage venture companies tends to be higher risk than investing in more mature businesses. The primary way we mitigate this is through providing highly diversified exposure to the asset class – diluting the company-specific risk that can come with a more concentrated portfolio. This is core to our strategy.”
Sirota says: “It depends on the maturity of the business. Startups and young businesses can have significant operational instability and helping a company build a strong management team is paramount to success. Later stage private businesses face other risks, namely access to capital. RTW has built companies de novo and has also become a creative capital provider, going beyond direct equity investments and engaging in exclusive licensing agreements, royalty-backed funding, rescue capital in distressed situations, and SPACs.”