Inside Trusts - PE Trust Club

Understanding trusts

Three levels of reading

DiscoverLevel 1

UnderstandLevel 2

AnalyseLevel 3

Start at the beginning or pick what interests you : each answer fits in a few lines and is illustrated by the news shared by the Club.

DISCOVER

The basics, no prior knowledge required.

What is private equity ?

Investing in companies that are not listed on the stock market, supporting them for a few years, then selling: that is the principle of private equity. It ranges from financing young companies (venture capital) to buying out mature companies using debt (LBOs).

Why is it so hard to access ?

Because private equity funds are built for institutional investors. The money committed is called gradually, then locked up for the investment period. Getting out early means going through the secondary market, which is a specialist market.

What is an investment trust ?

A listed company with a fixed number of shares. To exit, you sell your shares on the stock market to another investor: the trust itself has nothing to repay. It can therefore hold illiquid assets, such as unlisted companies, for as long as necessary.

Trust, closed-end PE fund or evergreen fund: what are the differences ?

	Listed PE trust	Closed-end PE fund	Evergreen fund
What you own	Shares in a listed company that owns unlisted companies	Units in a fund with a fixed lifespan	Units in an open-ended fund, with no end date
Your money is invested	All at once, when you buy the shares	Gradually, as capital calls are made	All at once, on subscription
To exit	You sell on the stock market, any day	Generally, you wait until the end of the fund, ten years or more	Through periodic redemptions, often monthly or quarterly, which may be capped
The price	The share price, which can differ from the value of the assets	The net asset value	The net asset value, sometimes with exit fees

How can you invest in trusts ?

There are several routes, depending on the investor’s profile and the amount being considered.

Directly, through an ordinary securities account (compte-titres), with a broker that provides access to the London Stock Exchange. UK trusts are not eligible for the French PEA. Costs to bear in mind: brokerage fees, conversion into pounds sterling and UK stamp duty of 0.5%, charged on the purchase of most UK securities.
Through a Luxembourg life insurance contract, via a dedicated internal fund (FID) or a specialised insurance fund (FAS). These wrappers can hold listed securities, including trusts; access depends on the amount invested and the policyholder’s assets.
Through funds that themselves invest in trusts, such as certain specialised professional funds, reserved for experienced investors.

Tax treatment differs from one route to another and depends on each person’s circumstances.

UNDERSTAND

How a trust works..

What is NAV ?

t is what the trust is worth: its holdings and cash, minus its debts, divided by the number of shares. In French it is called ANR. For a private equity trust, it is published monthly or quarterly, based on valuations that are often several weeks old.

Discount, premium: what are we talking about ?

The gap between the share price and NAV. NAV of 100 pence, share price of 80 pence: a 20% discount. Share price above NAV: a premium. This gap shows what the market is willing to pay, not what the underlying assets are worth.

Direct, fund of funds, co-investment: what are the differences ?

Some trusts hold their investments directly: this is direct investment. Others invest in funds managed by third parties: these are funds of funds. Others still invest alongside those funds, or buy existing fund interests: co-investment and secondaries. Many combine all three.

What fees ?

Management and operating costs, summarised in an ongoing charges ratio. Often, a performance fee, carried interest: a share of the gains for the manager, above a minimum return. And in a fund of funds, a second layer: the fees of the underlying funds.

How does value come back to the shareholder ?

Through three levers: growth in NAV, dividends and share buybacks. Each trust has its own policy, set out in its annual report.

ANALYSE

Reading between the lines of published documents.

What should you look at in an annual report ?

The change in NAV per share, total shareholder return, the discount. The year’s exits and their price compared with the latest valuation. Unfunded commitments, compared with cash and credit facilities. The ongoing charges ratio. The weight of the ten largest holdings.

What are unfunded commitments ?

Money promised to funds but not yet called by them. It is compared with what the trust has to hand: cash and undrawn credit facilities. The ratio between the two shows whether the trust can meet its capital calls without difficulty.

How is an unlisted company valued ?

At fair value, in line with accounting standards and the industry’s professional guidelines (IPEV). In practice, valuations rely on multiples of comparable companies or on recent transactions. The real test comes at the sale: the price achieved, compared with the latest valuation, shows whether it was realistic.

What role does the market environment play ?

Interest rates weigh on the cost of LBO debt and on valuations. The pace of exits determines the cash coming in. Both influence investor confidence, and therefore discounts.

What are the risks ?

First, losing all or part of your capital. Then: a widening discount, debt (at the level of the trust and of the companies it holds), a concentrated portfolio, valuations out of step with the market and, for a euro-based investor, movements in sterling (or in other currencies such as the US dollar, which affect changes in NAV).