Half-year results from Pantheon International (PIN ) have left investors on tenterhooks as to whether heavily discounted shares in listed private equity funds can mount a rapid recovery if the worst fears about unquoted companies are not realised in the next two months.

Like most private equity funds on the London Stock Exchange, Pantheon (a £2.5bn fund of funds) has seen its shares fall to a huge 46% discount as a result of investors’ concerns that the investment trust’s net asset value (NAV) is out-of-date. That cuts its market value to £1.4bn.

Pantheon, which invests nearly half of its assets in specialist private equity funds run by external managers, yesterday reported a 4% rise in NAV for the six months to 30 November. This was in line with the gain in the MSCI World index, which measures global public stock markets, but – as is too often the case – its shares went the other way, falling 8.5% in the period.

Worrying delay

The issue for investors is that the unlisted investments that make up about 90% of Pantheon’s assets are mostly based on September valuations. Although public stock markets started to rally at the end of next year, investors fear private equity valuations will have to fall to catch up with the big declines in listed equities in the first half of last year.

The interim figures contained some evidence for that suspicion. Venture investments in riskier start-ups, the smallest part of Pantheon’s portfolio, tumbled 15.9% to 3% of assets. More worrying perhaps, a larger bucket of more-established, but still early-stage, ‘growth’ companies fell 4.3% to account for 21% of assets.

Is there worse to come? Pantheon, which issues monthly updates, has already released its 31 December valuation. NAV per share of 467p was down only slightly from the 469.5p at 30 September. The reduction was due to currency movements and falls in the small number of quoted shares in recently floated companies the fund owns.

In short, it doesn’t provide evidence either way.

No ‘signs of distress’

John Singer, the private equity veteran who took over as chair of the Pantheon board last year, weighed in yesterday saying the concerns being expressed in the shares’ low rating were ‘excessive’. He pointed to the 31% average uplift Pantheon secured on exiting £111.5m of its investments in the six-month period, although the number of these was sharply down from the previous year due to subdued markets.

‘It should be pointed out that we are not hearing of signs of distress in the portfolio which is in part due to the hands-on approach of our managers but is also the result of the sector mix,’ SInger said.

Pantheon prides itself on the broad spread of its investments, though it has responded to criticism in the past that it was over-diversified, having nearly halved the number of its underlying company holdings to 597 from 1,000 a decade ago.

In a bid to keep a lid on expenses – which are always high on private equity funds due to the performance or ‘carry’ fees paid on realised profits to fund managers – Pantheon has steadily lifted to 54% the proportion held directly in co-investments in companies, thus avoiding fund fees.

Established companies

While investors look warily at the growth and venture investments, by far the biggest chunk of Pantheon is the 69% in medium-sized and larger companies whose managements the fund manager have backed in ‘buyouts’. These are generally in established, profitable healthcare services or accounting software providers, or ‘mission critical’ businesses as Helen Steers, the partner and manager at Pantheon Ventures, calls them.

Singer, a former co-founder of private equity firm Advent, said shareholders he met were pleased with Pantheon’s long-term performance with average annual shareholder returns of 10.5% since its launch in 1987.

The trouble is the performance over shorter, but still meaningful, time periods is totally spoiled by the chronic discount. According to data from Numis Securities, over 10 years to yesterday the investment trust grew NAV by 276%, well ahead of the MSCI World’s 198%. In reality, however, shareholders had to make do with 172% because of the way the shares lag the underlying portfolio.

The disparity is worse over five years with a 117% total return on net assets contrasting with just 35% for shareholders.

Limited buybacks 

Could Pantheon do more to buy back its shares to narrow the gulf with NAV? It repurchased £16m worth in the half-year but generated £34m in cash after making new investments, which is on top of £52m in the bank and its access to an unused credit facility of £500m.

Steers (pictured), who took over the portfolio three years ago from Andrew Lebus, told Citywire that Pantheon was ‘not complacent’ about the wide discount but said it was a sector-wide problem, not specific to the trust.

She said Pantheon had to balance the effectiveness of share buybacks with investment opportunities, such as the £93.5m recently ploughed in the new Pantheon Secondary Opportunity Fund. This specialises in buying the profitable rumps of mature private equity funds that investors want to exit. This comes as many institutions look to reduce their private equity exposure which rose as a proportion of their assets after the crash in equities and bonds last year.

Pantheon also needs to ensure it has the resources to meet investment commitments which stood at £848m, or more than half its market value, in November. Its current asset coverage ratio of 102% is up to the job but can’t be diminished too much as we head into a recession.

Is Pantheon a ‘buy’? 

So, Pantheon is probably not going to buy back loads of its shares. The big question is, should investors snap up what looks like a big bargain at Pantheon and rivals such as Harbourvest (HVPE ), NB Private Equity (NBPE ), Oakley Capital (OCI ) and HgCapital (HGT ) to mention a few? Should holders throw in the towel now after such frustrating underperformance?

The broad answer to the first question from investment company analysts is a resounding ‘yes’ (and presumably a ‘no’ to the latter). While they see the risk of writedowns in the short term, none of them believe they will be anything on the scale of the 30%-47% share price discounts in the sector.

Stifel analysts Iain Scouller and Will Crighton, who slapped a ‘buy’ on Pantheon and most of the rest of the private equity trusts last month, believed its 46% discount would prove too bearish, saying, ‘there may be positive surprises with regards to how resilient NAVs may be’. They put a 370p fair value on the shares which stand at 256p.

Jefferies’ Matthew Hose said Pantheon’s results showed a  ‘disconnect’ with lower earnings growth from its buyout companies, but a ‘broadly stable valuation multiple’ applied to them. That ‘may highlight that buyout marks need to fall’, he said, but still retained a ‘buy’ recommendation. He believed the maturing parts of Pantheon’s portfolio were ‘likely to engender a material uptick in exits once capital market conditions improve.’

Christopher Brown at JPMorgan Cazenove held an ‘overweight’ rating on Pantheon, calculating that, excluding cash and the listed holdings, its private equity assets actually stood on a 51% discount to asset value. That was completely at odds with recent results from US private equity (PE) funds, he suggested. 

‘We have seen 31/12/22 valuation marks for PE funds from many of the large US-listed private equity managers which as an early indicator of how GPs [general partners] are approaching fourth quarter 2022 valuations suggests in US dollar terms valuations are likely to be flat to low single-digit percentage gains,’ said Brown. 

If that is correct then private equity trusts must surely narrow from here. Don’t expect them to disappear completely as, with the exception of market leader and FTSE giant 3i Group (III ), most of the sector has traded on a discount since the 2008 financial crisis. 

Action not words

Listed private equity funds are always unloved, it appears, but the pariah status their current share price valuations suggest looks overdone. But, while the funds have to maintain strong balance sheets during the downturn, it would be good if they could deploy more in share buybacks to signal when their prices are really out of line. Actions rather than words might help restore some confidence.

At the same time, investors might need to recognise that there is a world of difference between established private equity investors like Pantheon and newer entrants such as Chrysalis (CHRY ), and previously Neil Woodford, whose mis-steps have helped to tarnish the idea of investing in companies ‘off market’.