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Simon Elliott: The private equity winners

Simon Elliott: The private equity winners

In contrast to the 2008 year-end results, the recent interim results for Private Equity investment trusts could be described as mercifully dull. Although every fund reported NAV falls for the six months to 30 June, the declines were mostly modest and largely a result of unfavourable currency movements.

HgCapital Trust was the best performer in NAV terms for the period with a fall of only 3% on a total return basis. This was a result of decent performances for a number of holdings including Pulse, the healthcare staff provider, which was written up.

In contrast, SVG Capital was the worst performer in NAV terms, partially reflecting its higher level of gearing and significant write downs to the valuations of Valentino and Marazzi.

2009 is likely to be a relatively quiet year for private equity funds in terms of investment activity. Investment levels are low, partly as a result of the lack of debt financing, and realisations have been limited to date.

Aside from Candover’s disposal of Wood Mackenzie, realisations were predictably very quiet in the first half of the year and the outlook is only slightly better for the second half. Investments or new commitments were few and far between although HgCapital Trust put £11m to work in Epyx, an electronic fleet management platform.

Overall, the recent batch of interim results seems to suggest that valuations have stabilised and that, in general, the underlying companies are weathering the economic downturn. Certainly, management teams at private equity firms appear to have been quick to encourage their underlying investments to reduce costs wherever possible and focus on avoiding bank covenant breaches.

Looking forward, there is a clear consensus that there will be substantial investment opportunities from next year assuming conditions continue to improve.

As a result, investors may be tempted to wait for activity to pick up before increasing their exposure to the asset class. However, we believe that the closed-ended private equity sector currently offers some decent opportunities. Clearly risks remain.

In the short-term, a number of underlying investments are vulnerable to further economic turbulence particularly given the high level of leverage. In addition, looking further ahead, questions remain over the ease of refinancing existing debt when it expires in several years time.

We favour funds that we believe are well placed to participate in potentially attractive investment opportunities over the next year which includes our core private equity recommendation, HgCapital Trust*. This fund has a diversified portfolio of pan-European investments including 28% in Healthcare and 32% in TMT. 46% of net assets are in cash and last year the fund made a £250m commitment to Hg6.

However, in contrast to other private equity funds, HgCapital has an opt-out provision on this commitment. Other funds with considerable cash resources that should be well placed to participate include Electra Private Equity, Graphite Enterprise and Dunedin Enterprise.

Simon Elliott is head of investment company research at Winterflood Securities. Hg Capital and Graphite Enterprises are corporate broking clients of Winterflood Securities.

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