Bargain season

I discern whether a stock is a bargain by looking at its relative valuation and future earnings growth potential. My signals are bullish on both counts for ICGT.

Firstly, with a price-to-earnings ratio of 12 times, ICGT is cheaper than its peer average (14 times). It also has a cheaper valuation than the FTSE All Share (14.5 times). Secondly, its portfolio earnings are forecast to grow 35.4% per year. That’s a pretty high growth projection. So, I am scratching my head as to why the trust has a widening price discount relative to its assets.

Discounts

In fact, the entire listed private equity sector is trading at historically wide discounts. It’s at odds with strong returns the sector has delivered over the years. ICGT could be one of the worst-hit victims.

Michel Degosciu, founder of specialist research and advisory firm LPX AG, believes the stock is trading at a “significant undervaluation based on the current discount level”. At last glance, the shares were trading at a 40% discount to assets. This comes despite the bullish projected performance of its underlying portfolio.

As a bargain hunter I obviously find this attractive. But I know all too well that discounts can be a poisoned chalice. The fact that demand for the shares is at a relative low is not a ringing endorsement in my eyes. The share price has been in freefall since February following a strong start. Degosciu attributes this to investors pricing in the impact of higher interest rates on its portfolio.

Admittedly, the trust has a high level of gearing (borrowing). This could limit the scope of the discount narrowing, particularly if its underlying assets get devalued.

Long-term outperformance

Regardless, the stock’s historical outperformance of the UK equity market is stark. Intermediate Capital is a big player in the direct private mezzanine sector. Its “historical track record in the mezzanine sector is very good”, according to Degosciu.

Additionally, the trust’s bias toward defensive growth companies is a positive for me. I feel this has contributed to its resilient NAV performance with companies that can grow earnings in today’s tough conditions.

All in all, I view the firm as a heavily discounted growth company that pays healthy dividends. In addition to income, the company has a long-term share buyback programme.

It’s a generous mix and suggests to me that the company’s helm have a bullish outlook. I am similarly bullish, and the stock is on my watchlist currently. It’s too cheap not to be. I just need to monitor the discount. If it continues to widen, the less likely I’ll be to purchase. Vice versa if it narrows.

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Why do I want exposure to private equity?

Buying and selling shares on the stock exchange is simple. Ownership stakes in private companies are difficult to buy and sell. Private equity investors expect to be rewarded for taking on the challenge. According to a JP Morgan report, private equity buyout, in particular, has delivered 1%-5% excess returns over pubic equity markets since 2009. I want to add private equity exposure to my public stock portfolio because of its potential to boost returns.

How I am getting private equity exposure in my portfolio

Buying directly into a private equity fund typically costs millions. Once invested, the money is locked up for perhaps a decade. Investing in a listed private equity investment trust costs as little as the cost of one share, and I could sell it the next day. ICG shares cost 1,176p each at present, 144% more than their cost at the end of January 2018, and pay a dividend of just over 2%.

The ICG share price is driven by changes in its net asset value per share (NAV). NAV is calculated by summing the value of investments, subtracting liabilities, and dividing this by the number of shares issued. ICG’s NAV has increased from 959p at the end of January 2018 to an estimated 1,422p on 30 April 2021. Right now, ICG shares trade at a 17% discount to the NAV. The discount has been as small as 10% over the last five years, suggesting potential share price gains from the discount narrowing.

However, what will really drive the ICG share price higher regardless of the discount is growing the NAV. ICG has built an impressive track record of unrealised NAV growth by investing directly and indirectly in buyouts of mid to large-sized companies in developed markets. These companies typically generate cash when bought and are not very sensitive to the business cycle, i.e., defensive picks. Exiting investments, in for example, an IPO, results in realised. NAV growth

FTSE 250-listed ICG Enterprise Trust

ICG does not use leverage in the traditional sense, but the underlying investments do have significant debt. This can lead to pronounced downsides in the NAV during economic downturns. Since NAV valuations are infrequent and private equity is considered risky, wide discounts in the share price to NAV (43% in March 2020) may occur and persist.

ICG charges management fees of 1.4% on the fair value of assets (excluding cash and closely held funds) plus 0.5% on outstanding commitments. There are also conditional incentive fees. The fees are high but appropriate in my view. I note that ICG’s 148% increase in NAV since January 2018 outperformed the FTSE 250 index and is a net of fees return. But, fees could become an issue if the portfolio does not perform as expected.

I am confident that ICG will continue to outperform, and I plan to regularly invest in ICG shares in my Stocks and Shares ISA to add private equity exposure.

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While investment giant 3i Group captures most of the attention of investors looking for exposure to private equity (PE), I believe a much smaller competitor offers greater value right now and provides far better downside protection against a market sell-off.

Over the last three years, ICG Enterprise Trust (LSE: ICGT) has seen its share price increase by 60%. Impressive but not as good as 3i’s doubled price over the same period. The problem is, I believe there is a lot of froth in 3i’s current market value… the stock trades at a whopping 40% premium to net asset value, and that gap has been growing in recent months — something I find concerning at this late stage in the cycle. By contrast, ICG Enterprise Trust’s shares trade at an 18% discount today. Given how similar the two companies’ investment criteria are, I find this wide disparity in share price hard to fathom.

Both vehicles provide investors with access to mature, middle-market private companies, primarily in Europe. The key difference is that just over half of ICGT’s investments are in funds managed by external PE managers, something I believe provides a welcome spread across a wide portfolio of underlying companies. Furthermore, the lion’s share of these third-party-managed investments is in high-quality funds managed by the likes of CVC, Graphite, BC Partners and other leading PE houses. Most individual investors would find it impossible to gain entry into these highly respected funds on their own.

One more thing. Emma Osborne, ICGT’s lead portfolio manager, has been in that role for 13 years and so has a detailed grasp of the business and deep relationships with those third-party fund managers. While some of 3i’s top executives have been in situ for a similar length of time, I don’t get the same level of comfort when examining the bios of the company’s investment managers closest to the coal face. In private equity, where investee companies can take five to eight years to reach an exit, longevity of service among the hands-on investment personnel really matters.

With over £700m of net assets, ICGT is no minnow. Plus, it offers substantially the same benefits as an investment in 3i — exposure to later-stage private companies without the risks associated with start-ups and venture capital — but, in my view, with significantly less risk of a collapsing share price. Its sizeable discount to net asset value is precisely the type of financial cushion I’m looking for in the market right now.

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What’s more, unlike many other funds, investment trusts are not limited in the assets they can hold, which allows managers to seek out the best ones to buy all over the world. And some investment trusts have been around for 100 years or more, so they have a lengthy record for investors to consider before buying.

A global outlook

EP Global Opportunities Trust (LSE: EPG) is UK-listed with a worldwide mandate. Since inception in December 2003, it has achieved a compound annual return for investors of just under 10.1% by investing globally in undervalued securities. 

EP Global’s broad investment mandate allows it to invest where many other funds would be afraid to tread. For example, of its top 10 holdings, only three are UK based (four including Royal Dutch Shell, although EP owns the A shares which are domiciled in the Netherlands). Non-UK holdings include pharmaceutical giant Novartis (Switzerland), Bank Mandiri (Indonesia), Commerzbank (Germany) and Shanghai Fosun Pharmaceutical (China). Together, the top 10 holdings account for just under 30% of assets and provide a great play on global growth trends. 

The net asset value of EP Global is 345p per share at the time of writing, so today the shares are trading at a discount of around 5%. As well as this discount, the shares offer a yield of 1.3%. The management fee is 1% per annum. 

Overall, if you’re looking for a play on global growth that’s got a track record of double-digit returns behind it, EP Global seems to me to be the perfect buy. 

Private equity profits 

Another trust I like the look of is ICG Enterprise Trust (LSE: ICGT). ICG is a private equity business, so its business model varies significantly from that of EP Global, but that hasn’t stopped the company from beating the market. 

During the past decade, shares in the fund have returned 123.9%, excluding dividends, compared to the FTSE All-Share Index return of 78.4%. 

According to the investment company’s results for the three months to the end of October, which were published today, it produced a total return of 9.1% for investors over the nine months to the end of the period, thanks to some key disposals and cash returns. Management is targeting a 20p per share dividend for the end of the year, as well as a share buyback. 

As it sells down some investments into a seller’s market, ICG is re-investing some of its proceeds into new opportunities such as the co-investment of £8.1m in Visma, provider of accounting software and business outsourcing services, alongside peer fund ICG Europe VI. 

So all in all, if you’re looking for a trust that’s got a record of beating the market by investing in unquoted securities, that’s also returning funds to investors, IGC ticks all the boxes. 

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