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JPM Private Equity trust: is there hope for recovery?

JP Morgan Private Equity's annual report, which is due out in a few weeks' time, is going to make interesting reading, says James Carthew.

JPM Private Equity trust: is there hope for recovery?

In August 2011 the JP Morgan Private Equity (JPEL) investment trust issued some zero dividend preference shares (which offer no income but a fixed return at a pre-agreed date), and it was clear that the returns on the portfolio needed to pick up if ordinary shareholders were going to benefit.

In the event, JPEL has performed very poorly since the deal. The net asset value (NAV) of the ordinary shares has fallen by 21.2% over the past year, while the average private equity fund of funds is up 1%.

To compound the problem, JPEL’s discount has widened, leaving the ordinary shares down 29.5% and the fund trading on a discount of over 43% – by far the widest in the group.

What went wrong?

So the big questions must be: what has gone wrong and is there hope for a recovery?

JPEL has a market capitalisation of £142 million. Like most private equity funds, it does not pay a dividend; 3% annual distributions to shareholders were mooted at launch but these did not materialise.

The management fee is 1% on gross assets. As I have said many times before, fees on gross assets encourage managers to use as much gearing as possible.

The pre-performance fee ongoing expenses were almost 3% last year – by far the highest of the peer group (excluding the fees charged by the underlying managers). The performance fee is 7.5% of returns above an 8% per annum hurdle.

Split structure

JPEL had a split capital structure from day one (splits issue two or more different types of share). At the start, it promised to not use gearing except on a short-term basis and with a maximum limit of 20% of net assets. As a way of controlling its discount, the plan was to allow semi-annual tenders for up to 15% of the share capital at NAV.

Shareholders had a good run for the first few years, but the credit crisis hit the private equity sector hard. As a buyer of secondary private equity portfolios, JPEL took advantage of cheap pricing to snap up blocks of stock from distressed sellers and, in 2008, to fund this it started using its debt facility.

JPEL’s own share price fell by two thirds from its peak in 2008 and its discount approached 70% in May 2009. However, it rebounded swiftly and the company fared much better than most of its group.

Over summer 2009 it raised a substantial sum from investors to continue its buying spree, which included issuing a new class of zeros and warrants (which exercise at stepped prices and mature in 2014). This was followed up by another share issue and zero issue in August 2011.

Widening discount

The regular tenders helped to keep JPEL’s discount narrow relative to its peers but the tenders have been shrinking. The latest, this February, was for 3% of the issued share capital. This may be one reason why the discount is widening.

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