Abrdn’s Gauld: private equity continues to outperform

Alan Gauld of Abrdn Private Equity Opportunities Trust

The lead manager of the £1.1 billion Abrdn Private Equity Opportunities Trust plc (APEO) has responded to recent criticism of private equity investment companies by saying “PE will continue to outperform and justify its illiquidity premium in relation to public equities.”

Alan Gauld said the private markets remain the best way to access growing niche market leaders and disruptive businesses of the future.

The Association of Investment Companies (AIC) said private equity investment companies have delivered an average return of 409% to investors over the past 10 years compared to 156% for all investment companies.

However, despite this strong long-term performance, the AIC said 14 out of 17 investment companies in the private equity sector are trading on double-digit discounts.

Recent criticism of the sector has also focused on share buybacks, fees and valuations of underlying portfolio companies.

Private equity investment companies offer access to an asset class that is normally inaccessible to private investors and their shares are traded on the stock market.

To discuss the criticism, private equity fund managers took part in a media webinar hosted by the AIC.

Alan Gauld, lead manager, Abrdn Private Equity Opportunities Trust (APEO), said: “We remain very positive and confident on the longer-term prospects for private equity.

“There will of course be headwinds, not least in terms of higher interest rates, higher inflation and more sluggish economic growth.

“Whilst we don’t believe private equity will replicate the returns seen over the last ten years, on a relative basis we still believe PE will continue to outperform and justify its illiquidity premium in relation to public equities.

“Generally, private equity firms are much better at buying, creating value and supporting their portfolio companies than they were a decade ago.

“They are also much more specialised by sector and sub-sectors.

“Today they typically have operational experts on the payroll to help identify and accelerate portfolio company organic growth, and ‘buy-and-build’ strategies tend to be a bigger part of their investment plans.

“The modern-day buyout manager takes full advantage of the governance model of private equity, which involves majority control (or at least significant minority investment) of the portfolio companies plus setting and implementing strategic direction.

“Gone are the days of passive investment and reliance upon financial engineering; those types of private equity managers would not survive today.

“It is also significant that companies continue to stay private for longer. According to data by Edison, there are around 10,000 PE backed companies and almost 6,500 growth and VC companies – so around 16,000 to 17,000 companies.

“In 2000 this combined figure was less than 3,000. Contrast that with US-listed companies for example – in 2000 there were around 7,000 but today there are now less than 5,000, a trend which goes further back to the 1990s as well.

“Access to private capital continues to increase and PE is expected to roughly double in size over the next decade, from its current level of around $5trn assets under management.

“Therefore whatever the latest investment trends, whether it is AI, digitisation, ESG, the green transition or medical technology, private equity will be leading the way with investment in these areas.

“In my view, the private markets remain the best way to access growing niche market leaders and disruptive businesses of the future.”

On his general outlook for private equity, Gauld said: “APEO is focused on the buyout space and, from my experience, buyout valuations have been relatively conservative over the last decade or so.

“That’s why we have continued to see an average valuation uplift, when a private company is sold, of around 25% during that period, when compared to the unrealised valuation two quarters prior.

“Even exits in the six months to 31 March 2023, with all the uncertainty and volatility in financial markets, have been at a 16% uplift.

“There is a great deal of governance underpinning PE valuations. In our portfolio, all investments are audited at an underlying level at least annually and then a sample of portfolio companies are then audited again by APEO’s auditors.

“That’s all before we even get to the overarching scrutiny by the manager, the board and the Audit Committee.

“All investment valuations in APEO are in line with IFRS or US GAAP and IPEV guidelines, and are revalued bottom-up every quarter, mostly based on earnings.

“Regarding fees, PE is a relative expensive asset class but the NAV returns, which are net of fees, continue to be strong.

“PE involves active value creation, which requires serious resource and expertise. To make differentiated returns in PE it is about accessing and partnering with the best private equity firms that generate the best net returns.

“These are typically oversubscribed and hence have negotiating power when it comes to fees.

“To help tackle this in APEO, the Manager has a flat 95 bps fee and has increased direct co-investment, which typically has no underlying fees attached, from 0% of the portfolio at the start of 2019 to 21% at the end of 2022.

“That combination means investors will benefit from the increased performance potential of direct private equity at no additional cost.”