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New private equity ZDPs offer 8% pa, should you buy?
by Charlie Parker on Nov 10, 2009 at 12:22
Some serious investors are calling the private equity market at the moment, not least among them Mary Ann-Daly the head of private clients at Cazenove.
Yesterday she told Citywire that their private client portfolios are moving from a 0% to a 3-5% weighting in private equity. The move is spurred by the discounted opportunities still available in a market starved of bank credit.
For Cazenove and most private clients zero dividend preference shares look like an good entry to the market. Firstly, they do not promise to create 'false liquidity' in an asset class which provides little (as the Arch Cru fund range famously tried to do last year). Rather they acknowledge that money must be committed to private companies for a reasonable period of time, like five years.
Secondly, and perhaps more crucially, they are designed to offer a low risk method of accumulating returns which is taxed as capital, rather than income.
Cazenove has been backing a recent zero issue from Electra - one of the most experienced private equity managers. For a sector starved of capital Electra's success in raising money has prompted other trusts' to follow.
Three other trusts are currently trying to offer new shares to the market. In the running is F&C Private Equity, managed by Hamish Mair, JP Morgan Private Equity - which is to offer a new tranche of its existing 2015 zeros - and the lesser known NB Private Equity.
Of course there is an elephant in the room for these trusts. Namely: over-commitment. Because of the horrors of being a private equity fund of funds manager - which is what these trusts effectively are - stuck with too much cash many managers have over committed to deals. It introduces a substantial risk for investors of course because if all the commitments are called it could spell the end of a trust.
It means that the investment case for these vehicles relies primarily on an investors' view of the current liquidity environment. In the scenario where bank lending remained highly depressed then private equity businesses will be unable to attract bank lending and few of these commitments will be called. This of course mans that investors' cash will sit on the sidelines earning a very modest return indeed.
In the scenario where credit growth returns rapidly then the trusts could well find themselves over committed. F&C Private Equity for example has some £129 million of unfunded commitments, equivalent to 89% of net assets, according to brokers Numis.
This is clearly troubling the board of the trust which wrote to shareholders that it had asked the manager: 'to explore opportunities to realise opportunities to reduce positions in non-core assets where to do so would achieve a satisfactory balance between cash inflow, impact on asset value and commitments relieved.'
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