Listed PE yields results

Regulation, the developing world, poor investment performance and changing demographics are all exerting pressure on the investment community. The major institutions, which most general partners rely on to fill their funds as limited partners, are less able to invest than they were in the past owing to reduced distributions and, for some, regulatory constraints.

But their appetite for private equity remains, according to Ian Armitage (pictured), chairman of HgCapital and of trade body LPEQ (Listed Private Equity): "If you poll investors, most of them are actually looking to increase their allocation to alternatives, and that includes private equity."

The problem private equity needs to address however, is that many of the investors that have traditionally backed the asset class now want - or need - more liquidity. Banks and insurance companies are facing tighter regulations stemming from the financial crisis of 2008/09, which can sometimes be incompatible with the long-term, illiquid nature of LP funds.

Equally, the pensions business is undergoing major, demographically driven changes. Improved diet and healthcare mean people are frequently living 20 years or more into retirement, which has meant many old-style defined-benefit (DB) pensions have largely failed to raise enough cash from their investments to match the increased lifespans of their members. The resultant shift from DB to defined contribution (DC) means private equity may have to re-invent itself to continue to attract pension funds: DC pension investors need both low ticket costs and liquidity.

"If we look at the traditional private equity investor mix, banks, insurers and public and private pension funds make up about 60% of that," says Armitage. "For some of these, justifying an allocation to a 10-year vehicle with no liquidity is more difficult than it was, and the move to DC schemes means there is a need for more liquidity in the pension fund world."

The answer could be listed funds, as suggested by industry veteran David Currie in a video interview with unquote" last month just before his retirement from SL Capital.

However, while it would seem safe to assume that investment will begin to move away from LP funds and towards listed vehicles, this has not yet happened, with most public funds seeing wide discounts to net asset value (NAV) and share prices that are below or only just catching up to their pre-crash peaks.

"It's a logical development that more investors would flock to listed funds given these pressures, but that doesn't mean it will happen quickly," says Hamish Mair, head of private equity funds at F&C and manager of the F&C Private Equity Trust.

The numbers don't look great. According to LPX50, an index of the top 50 listed funds, five-year returns are -38.07% as of 31 June 2012. However, over three years this jumps to 60.66% and 1.96% on a one-year basis.

Despite most funds displaying strong NAV performance, share prices haven't followed and discounts have remained significant. Many managers are turning to other strategies to convince investors their funds are worth it. Many funds are now actively seeking to increase yield as a way of attracting investors and closing their discounts.

Closing the gap

Mair's F&C Private Equity Trust was the first fund to take advantage of changes to the rules which govern investment trusts, which enable greater freedom to pay cash reserves to investors. F&C's fund promised to pay out a regular, semi-annual dividend with an equivalent yield of not less than 4% of NAV.

Mair believes the move has been a success: "The reception we received from shareholders has been universally positive, and I've spoken to a number of non-shareholders who are interested in the regular dividend. We were sitting around £1.60 when we announced it, and today we're at £1.69 and we've paid a 5p dividend, so far so good."

David Zalaznick, investment manager and founder of JZ Capital Partners, which runs a London-listed fund focused on micro-cap companies, believes regular dividends can be very beneficial for listed private equity investors. "Prior to introducing our regular dividend, payments to investors were lumpy and unpredictable, which is not ideal. Now they are getting a reliable yield, which they welcome in a low interest rate environment," he explains.

Investors might have also hoped that such measures would have closed their discounts, and while both F&C and JZ have seen discounts narrow recently, both admit it is hard to strip out how much of this is due to the dividends and how much is due to general economic improvements and continuing growth in NAV.

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