GB-EN Intermediary

The BMO Private Equity Trust view

The characteristics, risks and opportunities of private equity investing
April 2022
Hamish Mair

Hamish Mair

Managing Director, Head of Private Equity, Private Equity

Share

Share on facebook
Share on twitter
Share on linkedin
Share on email

Subscribe to our insights

Mind the gap – the private equity opportunity emerges

Private equity has been around as a mode of investment for a long time. The investment trust sector made what would now be considered private equity investments back in the 19th Century. The years following the great depression of the 1930s and the post war period saw identification of a funding gap. This gap was for companies that were not big enough to go public but also often struggled for adequate bank finance – the so called ‘Macmillan Gap’ after the Scottish lawyer who chaired the government sponsored committee which produced a report on the subject. Part of the solution was the 1945 foundation of the Industrial and Commercial Finance Corporation (ICFC) later known as Investors in Industry or 3i. This organisation dominated private equity in the UK for decades but from the 1980s onwards when the concept of the management buy-out became both technically feasible and popular there was a proliferation of new private equity firms. Quite quickly the practice of private equity spread to continental Europe. Much of the early learning was derived from the LBO – or leveraged buy-out – sector pioneered in the US in the 1970s and 1980s. By the late 1990s certain trends were in place and BMO Private Equity Trust, originally a spin-off of the large long-established general investment trust Scottish Eastern, orientated itself to provide shareholders with beneficial exposure to these trends.

Information advantage – scope for finding hidden value

Firstly, private equity, with management buy-outs as its principal mode of investment, was spreading across Europe and was deepening as a means of investment in small and medium sized companies in the UK. Private equity is conducted in an innately inefficient ‘market’. There is little readily available information and no prices conveying that information. It followed that those able to look closely at companies and conduct their own research often found real hidden value in under appreciated or under managed businesses. The European economies, whether by design or unconsciously, adopted this ‘Anglo-Saxon’ form of capitalism and the EU single market saw hundreds of private equity firms come into existence.

Alignment of interests

BMO Private Equity Trust started investing in new private equity funds in the UK and Europe – often favouring newish groups, so called emerging managers. We also found some great opportunities in the US. The essence of private equity is alignment of interest, deep knowledge, and domain expertise. Private equity investors in funds or co-investments are investing alongside lead managers and the management teams of the underlying companies. Every one of these tiers is invested in the business and they share directly in its successes and failures. Private equity investors and management invest material amounts into their investee companies, confident in their ability to drive returns and with detailed knowledge of the associated risks.

Quote icon

“The essence of private equity is alignment of interest, deep knowledge, and domain expertise.”

Considering risk and reward

Elevated risk is a fact of life for private equity investment. The risk comes from the absence of a market in the shares, the consequent lack of price discovery or liquidity. An investment is made through a negotiated transaction and once made cannot easily be reversed. Private equity is inherently long term in nature with the usual planned holding period of around 4 or 5 years. The companies are usually not well known, and they can be quite small with highly geared balance sheets. They typically have strong management, but they rarely have management strength in depth. These risks may sound significant and private equity should be considered the ultimate caveat emptor asset class. However, the experienced private equity investor will assess and price all the associated risks, demanding a potential high return as compensation. Usually, the private equity house is aiming for a net return at the level of the individual deal of more than 25% per annum and even for a well-diversified fund at 20%+. Returns are not usually consistently this high because even the best investors are not infallible but returns typically exceed those of the stock market.

Diversification & alignment of interests – a potent combination

Private equity tackles risk at the investee company level through upfront research and diligence but at the portfolio level it is done principally through diversification. This is the only proven way of reducing the heightened risk in private equity down to more moderate levels. The recent pandemic has highlighted the benefits of diversification. Nearly all private equity firms faced severe challenges when the world economy received its biggest shock in living memory. But many used their ability to intervene and help their businesses – they generally control the boards and can influence management quickly and directly – and the result was far fewer crises than expected.

BMO Private Equity Trust which benefits from a range of investment partners leading our fund and co-investments has enjoyed impressive returns in the calendar years 2020 and 2021. Significant exposures to information technology and healthcare helped but mostly this was down to the private equity business model, with alignment of interest at its core, proving resilient in the pandemic. This was demonstrated time and again through a flow of realisations that rose on the recovery and the associated flow of fresh capital into this increasingly appreciated asset class. Since its launch BMO Private Equity Trust has delivered returns that are approximately double per annum what the stock market has delivered. Hopefully we can continue in this vein for many more years to come.

Risk Disclaimer

The value of an investment is dependent on the supply and demand for the shares of the Investment Trust rather than its underlying assets. The value of an investment will not be the same as the value of the Investment Trust’s underlying assets.

Views and opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management.

Past performance is not a guide to future performance. Stock market and currency movements mean the value of investments and the income from them can go down as well as up and you may not get back the original amount invested.

Related articles

Investment Trust
Containerships with the city background
7 min read
May 2022

Inflation is back – what next for small caps?

We consider what inflation means for equity markets
Investment Trust
White facade of a large building with many black windows
7 min read
May 2022

Refocusing on fundamentals in challenging markets

How is F&C Investment Trust positioned against the current backdrop?
Investment Trust
Two employees discuss business matters
6 min read
March 2022

Small Caps so far in 2022 – is this a longer-term opportunity?

Small caps have sold off, underperforming the wider equity market in the opening months of 2022. Lucy Morris discusses the top-down economic and market factors driving this underperformance and looks at how individual companies are reacting as well as looking at the factors that may trigger a recovery in performance.
Investment Trust
Bright front of the building with many windows and a lit statue in the center
6 min read
March 2022

Re-learning the lessons of investing in a time of war and inflation

Peter Hewitt, Portfolio Manager, BMO Managed Portfolio Trust, discusses how to navigate the investment challenges of 2022
Investment Trust
Brunette sitting at the desk and checking graphs on monitors and sheets of paper
7 min read
February 2022

The time for stock-picking investors to shine

Why stock-picking – based on fundamental analysis – is the best approach
Investment Trust
Large warehouse with glass wall and multiple doors for loading trucks
7 min read
February 2022

Seeking value in real assets

Could now be the time for real assets to come into their own?