1875 Autumn 2021 Stockbroking

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A PUBLICATION FROM REDMAYNE BENTLEY

AUTUMN 2021

PRIVATE LIFE A WALK DOWN PRIVATE EQUITY LANE THE SCHIEHALLION FUND Are we at the foot of the mountain?

HOW CAN I INVEST IN PRIVATE EQUITY?

Private Equity

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PRIVATE LIFE

CONTENTS

JAMES ROWBURY | INVESTMENT RESEARCH LEAD INTRODUCTION 2 Private Life

INSIGHT 4 A Walk Down Private Equity Lane

THE SCHIEHALLION FUND Are We At The Foot Of The Mountain?

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HOW CAN I INVEST IN PRIVATE EQUITY? PRIVATE INVESTMENT AND INNOVATION

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Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned 2

The prestige of ‘Going Public’ was once the greatest ambition of founders and boardroom executives. From Motor City to Silicon Valley, companies would build their brands and sell the public a piece of the pie through a public market equity raise, or “initial public offering” (IPO). Going public was symbolic of a company’s status in the corporate world, a badge of honour. Though, beyond the kudos, listing on the stock market meant money… a lot of money.

Growing businesses have relied on the public for centuries. Investment has provided the capital to expand into new markets and products and, rather than ask the bank for a loan, they could just sell a piece of the company for the privilege of doing so. If things go well, the price of shares will rise and the company can raise even more capital but relinquish a smaller slice of the business. But, if investors’ expectations aren’t met, shares can plummet and a company can become insolvent. It’s a risky game that’s built on the sentiment of others.

It’s even riskier in today’s world, where information is fast-moving and freely available. Investors have become fickle and company management are hell bent on beating analyst estimates in their next quarterly earnings numbers. It is very different from the likes of mid-20th Century megalistings such as Ford Motor Company and Johnson & Johnson, where going public was still a relatively novel idea; giving the average person a chance to own equity in a company, rather than keeping ownership a private affair, previously a game reserved for deep pockets and the right connections.

As my colleague explains (See: A Walk Down Private Equity Lane), some of the most exciting companies are now choosing to remain private for longer. Not least, the market dynamics have changed enormously in the last few decades. Trades can be executed in seconds on a smartphone, while

views, tips and company information can be found with the same ease.

While these are all innovations that foster a more inclusive financial environment, it has created a more fickle one - one that can turn a company’s fortunes on its head because of a viral image.

Fast-growing businesses are understandably cautious of going public these days. There is a raft of innovative technologies out there that are looking for more patient investors with long-term capital. They want investors who really understand their creator’s vision. But that doesn’t mean us normal folk don’t get a chance to buy in. The Schiehallion Fund is one such investor with a reputation for aligning themselves with the foresight of the companies they invest in (See: The Schiehallion Fund: Are We At The Foot Of The Mountain?).

All the investments of the fund are co-invested with several like-minded participants, meaning the fund doesn’t have the pitfalls of more opaque private equity solutions in the market.

A growing private market doesn’t mean less opportunity, but investors must take a different mindset before diving into this arena. It can often be less transparent and full of new lexis to get your head around (See: How Can I Invest In Private Equity?), but, most importantly, it requires patient capital. This won’t yield results overnight.

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A WALK DOWN PRIVATE EQUITY LANE BEN STANIFORTH | RESEARCH ANALYST

For many years, private equity was seen as almost alien by most retail investors, with the perceived risk too high and a general lack of understanding of the industry. It’s had its fair share of bad press too; for example, the once revered fund manager Neil Woodford, whose fall from grace lost investors millions and locked their money away for months, whose failure, in part, was due to his reliance on poorly run private companies that provided little in the way of liquidity.

However, impressive performance during 2020/21 and a greater access to retail investors has seen the popularity of private equity funds spike. Assets under management across global private equity vehicles rose 6% in the first half of 2020 to US$4.5tn, an all-time high and the driver of the majority of the growth in private asset classes. This has steadily coincided with the rise of alternative assets within investors’ portfolios, jumping from 9.8% to 15.2% between 2008 and 2019; according to consultancy firm McKinsey, with private equity now at its highest level ever at 5.7%.

This improved level of inflows has helped buoy the IPO market for private equity vehicles in recent years.

Goldman Sachs-backed Petershill Partners, one of London’s latest listings, raised £1.2bn which it has earmarked to fund further acquisitions. The event saw impressive interest from institutional investors especially, who were keen to allocate towards the private equity vehicle. However, it is not simply private equity funds that are keen to capitalise on the trend; investment trusts that hold plain vanilla listed stocks and small private equity allocations, so-called ‘hybrid trusts’, have increased in popularity in recent years. Assets such as Scottish Mortgage Investment Trust, the UK’s largest investment trust, currently account private companies for 21.4% of their portfolio and encompass well-known names such as ByteDance, the company behind the social media app TikTok and Epic Games, owner of well-known video game Fortnite.

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CBOE UK ALL COMPANIES

HABOURVEST GLOBAL PRIVATE EQUITY

3i GROUP

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CBOE UK All Compani es

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Harbourvest Global Private Equity

Chart 1 – Five-Year Private Equity vs UK Stocks This apparent appetite for private equity investments has not been without merit. Performance of the two largest UK-listed private equity funds has well outstripped that of the general UK stock market over various periods, as shown in the chart above. While charges do tend to push towards the higher end with such investments, the performance and diversification benefits displayed far compensate for such risks and provide long-term investors with a source of impressive outperformance against equity markets through a broadened portfolio, accessing parts of the market that would be otherwise unaccessable to retail investors.

The pandemic has certainly exacerbated this trend given that the performance of typical private equity funds firms has been good thanks to their technology exposure, a sector that has continued to perform well despite the COVID-19 crisis.

However, perhaps a more overarching reason behind the growth of private equity is that many fast-growing companies are now choosing to remain private for a longer period of time. Many tech companies have shunned raising funds through public markets, a historically logical next step for many private companies, creating a new breed of fast-growing private companies called ‘unicorns’, those businesses with a value north of US$1bn. In fact, between 2011 and 2015, more than 40% of the unicorns that chose to list on public markets were at or below their final private market valuations, a shocking statistic which no doubt worries many owners of such businesses. Coupled with the poor potential returns of public markets is the lure of private markets, which possess an ever-increasing availability of capital and fewer disclosure requirements, meaning that there is often no need for unicorns to risk going public so early. Instead, they can continue to grow with a small number of long-term minded investors and choose to go public later in their lifecycle, when they are far more mature and likely to attract stronger initial returns.

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3i Group

Source: Factset However, while returns in recent years have been strong, there is a major factor to consider going forward: rising interest rates. A phenomenon expected in the coming years thanks to high inflation, this typically affects fast-growing companies more than others. Higher rates mean higher interest payments on debt, which smaller, faster-growing companies often have large amounts of, as well as a larger impact on future cash flows thanks to a higher discount rate. This tends to have an outsized effect on fast-growing firms versus their larger peers given that a greater proportion of their valuations are linked to future cash flows. While not every private equity fund invests across such companies, some of the best performing funds over the past ten years have employed a strategy of searching for fast-growing and innovative firms. This is certainly not to say that such funds will not continue to perform well or that the companies in which they hold stakes will suffer greatly, however, it is something to keep in mind when evaluating which assets to invest in.

The key again, then, is diversification. Not just of one’s overall portfolio but also of the strategies of the assets which they employ. Well-chosen private equity funds have, over the long term, provided investors with a strong source of alpha and diversification as well as access to markets which typically would prove unattainable to the average investor. However, holdings and knowledge around the private equity industry remain thin and have, in many cases, prevented investors from accessing such vehicles, but with companies now staying private for longer and some of the most exciting opportunities parked firmly in the private space, it is no longer an allocation investors can ignore.

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THE SCHIEHALLION FUND ARE WE AT THE FOOT OF THE MOUNTAIN? ADAM MCMAHON | INVESTMENT EXECUTIVE

The formations of modern private equity (PE) began in 1978 when Kohlberg, Kravis and Roberts raised US$30m from a secret circle of well-connected, high-net-worth individuals to fund KKR & Co’s first buyout. For decades, the PE sector had a notoriously exclusive reputation for serving only the uber-rich, knowledgeable investor. In recent years, the industry has become readily accessible to any investor as big players such as Blackstone have gone public and investment vehicles targeting the sector have been listed on major stock exchanges. One vehicle, recently launched by Baillie Gifford and named after the 1,000m high Scottish mountain, offers an exciting entry to some of the world’s most promising areas of the private market: the Schiehallion Fund.

A common misconception of private equity investing is that it exclusively targets only high-risk, very small companies. As my colleague discusses in (See: A Walk Down Private Equity

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Lane), companies are increasingly deciding to stay private for longer, providing new opportunities to invest in ever larger and more profitable private companies. The fund has a strong management team known for the success of Baillie Gifford’s flagship Scottish Mortgage Investment Trust; lead manager Peter Singlehurst is head of the Private Companies Team and was the first from Baillie Gifford to work exclusively on private company research. He has worked to develop the company’s well-respected internal infrastructure to focus on long-term alignment with company management teams and promotes a low-cost approach to private investing. Uniquely for the private equity space, the team look for investment opportunities where management can be trusted to act in the interests of growth for the company without investors interfering to influence change. The fund has been amongst the strongest performers in the private equity space since its launch at US$1 in 2019, with investors more than doubling their money and far outperforming the FTSE All Share Index. In addition to the

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The fund focuses predominantly on companies that are at the cutting edge of technology and innovation, driving the longterm growth opportunities desired by private equity investors.

In terms of holdings, the fund’s largest holding at 10.2% of the portfolio is Affirm, a financial technology company which went public on the NASDAQ exchange in January earlier this year. Affirm was founded in 2012 by Max Levchin, co-founder of PayPal, and offers instalment loans for consumers to use at the point of sale to finance a purchase. Since its launch, the company has partnered with the likes of Walmart, Spotify, Peleton and countless others, and has share price growth of around 29% since its floatation.

Another of the largest holdings is Chinese tech giant ByteDance, owner of TikTok, the social media company taking the world by storm. The company remains privatelyowned despite numerous rumours of a public listing and is estimated to be worth upwards of US$250bn after doubling its year-on-year revenue to a staggering US$34bn during 2020.

Furthermore, the company appears to be separating itself from the turbulent waters of government regulation by keeping on good terms with the Chinese Communist Party (CCP).

ByteDance has been working in accordance with the CCP and its wishes to avoid mistakes made by the likes of ride-hailing app Didi Chuxing and technology giant Tencent holdings, which have been on the receiving end of fines and bans for various violations.

Furthermore, standing at 5% of the portfolio is Elon Musk’s SpaceX, the space exploration company founded with a primary goal of reducing space transportation costs to enable the colonisation of Mars. After soaring into the new era space race, the company has become the first commercial spacecraft to deliver cargo to and from the international space station, and in 2020 was the first to take humans there as well. Based on the most recent US$850m funding round in March, the company was valued at US$74bn.

On the whole, the Schiehallion fund offers investors a unique proposition to access some of the most exciting pre-IPO companies in the world, at a cost of 0.9% of Net Asset Value, lower than any comparable fund in the space. The team at Baillie Gifford are extremely well placed to operate effectively with in the private company space; the asset manager has proved through its long-term positions in Jack Ma’s Alibaba leading to a referral for private investment in Ant Group, and likewise with Elon Musk and Tesla leading to a private investment into Space X. One of the most sought-after investment vehicles in the space, press coverage surrounding the fund has been kept to a minimum, a tell-tale sign of more than enough demand for shares without requiring much advertisement. The fund has performed extremely well over

the last year, returning 91%, and is well placed to capture much of the future growth opportunities often unavailable to most investors. While previous performance is no indicator of future growth, many aspects of this fund point to a very attractive growth opportunity, and it is likely that we are nowhere near the share price summit.

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On the whole, the Schiehallion fund offers investors a unique proposition to access some of the most exciting pre-IPO companies in the world, at a cost of 0.9% of Net Asset Value, lower than any comparable fund in the space... The fund has performed extremely well over the last year, returning 91%, and is well placed to capture much of the future growth opportunities often unavailable to most investors.

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ordinary shares, the fund issued an additional C share offering in April to raise a further US$700m for new investments, to be merged with the ordinary shares on a NAV-for-NAV (Net Asset Value) basis once substantially deployed. Net assets for the ordinary shares stood at US$810.7m at the last reported date of 31st July, with net assets for the C shares at US$698.3m.

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HOW CAN I INVEST IN PRIVATE EQUITY? BEN PICKETT | INVESTMENT RESEARCH

Private equity is a buzz term for investors. It is an increasingly popular asset class often touted as a vehicle for high returns, though admittedly it comes with higher risks. We look at the ways investors can gain exposure to the trend, how they work, and assess their merits, namely Primary Investment, Secondary Investment, and Direct Co-investment.

PRIMARY INVESTMENT Primary investment, or fund of funds (FOFs), is investing in a private markets fund as capital is being raised, which then deploys its capital in a portfolio of primary fund investments.

Such a route offers investors access to many private equity (PE) managers and a variety of private companies through a single investment. Naturally, this provides diversification benefits, reducing risk and volatility by minimising the impact of any one investment going wrong. Small investors benefit from being able to access this range of opportunities as it pools their funds, since private markets usually only take large lump sums seriously. FOFs have their own investment teams who perform their own due diligence, which in theory means that the underlying funds should be sound.

However, investors invest in private equity to achieve higher returns. Work by Cliffwater research has shown that, net of fees, private equity doesn’t outperform the markets on aggregate. Evidently, some PE funds have performed exceptionally, showing that the asset class can provide best-in-class performance, as long as you invest your money in the right fund. This aggregate figure reveals that there are many underperforming managers. If investing in PE it is all about picking the right investment house, it makes little sense to spread your bets widely with a large group of investment houses you don’t get to choose. It’s better to find a few that you hold conviction in and, as always, understand.

In diversified portfolios, PE is usually the aggressive, returnboosting component, and FOFs risk overdiversifying this section from performing its function.

FOFs also suffer from higher expense ratios than other funds through two layers of fees – its own fees to pay its team, and the fees of the funds it invests in – which are corrosive to returns. The key argument of diversification is also misleading, as the breadth of funds FOFs invest in make it likely that multiple funds are invested in the same company. This is not necessarily negative, as it counters the over-diversification criticisms, but knowing this information is central to managing risk, and the FOF structure is very

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opaque, making risk management hard. Opacity is a common criticism of PE, as it gives a stronger focus on ‘star managers’ and allows funds to charge higher fees.

SECONDARY INVESTMENTS Secondary investments are where a buyer purchases existing private equity. Sellers are often other PE vehicles looking to reduce exposure to a region or business growth stage, or release liquidity if not ready to fully exit the investment.

As these deals enter at a later stage, they bear less risk and commensurately lower returns, though these are boosted by the fact that the deal is priced at a discount to its asset value – the seller effectively pays to exit earlier than expected and needs liquidity more than profits. When secondary investments come from other investors looking to reduce exposure, they also mean the buyer will gain less exposure than outright investment, meaning secondary focused funds tend to be more diversified. One of the key advantages of secondary funds is that there is limited ‘blind pool’ risk. This is where primary fund investors must part with their cash before they know what its managers will buy, which obscures predictions of performance and risk.

CO-INVESTMENT Lastly, direct co-investments are where PE funds pool together to make an initial investment in a private company, which is then paid in instalments, or ‘funding rounds’. This form of investment yields the most freedom to the fund, which can decide its exposure, craft complex deal structures and reduce risk by taking on other partners. This structure is useful when a PE firm has too many commitments to fully take up an opportunity, but still wishes to do so by bringing in another investor to plug the funding gap. Usually institutions, these investors can also be private individuals.

There are more risks to these investors, who are a separate entity, partly due to the fact that they are responsible for analysing and negotiating on their own behalf, while the general partner will charge hidden fees. The main risk comes from the high risk of failure of the individual business since the co-investor has no diversification benefits in this deal.

In reality, PE funds are a mix of the three. It is crucial that investors know what they are buying to help understand the risks they face, especially when investing in an inherently riskier asset class. In deciding which mix is most appropriate for you, it is central to our investing philosophy that investment decisions should be made in the context of your personal goals and objectives.

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EXAMPLE PRIVATE EQUITY FIRMS WHAT IS A PRIVATE EQUITY FIRM? A private equity firm is an investment management company that invests in businesses with the goal of increasing their value before selling the company at a profit. They use capital raised from limited partners (LPs) to invest in promising companies, often taking a majority stake. Private equity firms often have majority ownership of multiple companies at once. A firm’s array of companies is called its portfolio. Private equity firms will receive a periodic management fee as well as a share in the profits earned (carried interest) from each private equity fund managed.

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BLACKSTONE GROUP

CARLYLE GROUP

KKR & CO.

TGP CAPITAL

WARBURG PINCUS

FOUNDED: 1987

FOUNDED: 1976

FOUNDED: 1992

FOUNDED: 1966

NOTABLE INVESTMENTS: ZOOMINFO, DUFF & PHELPS, PPD, GOLDEN GOOSE

NOTABLE INVESTMENTS: EPIC GAMES, OPTIV, UFC, AXEL SPRINGER SE

NOTABLE INVESTMENTS: MCAFEE, AIRBNB, UBER, SURVEY MONKEY

NOTABLE INVESTMENTS: AIRTEL, 1&1 IONOS, IMMARSAT, GOJEK

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NEUBERGER BERMAN

CVC CAPITAL PARTNERS

EQT

ADVENT INTERNATIONAL

VISTA EQUITY PARTNERS

FOUNDED: 1939

FOUNDED: 1981

FOUNDED: 1994

FOUNDED: 1985

NOTABLE INVESTMENTS: TELXIUS, MHS GLOBAL

NOTABLE INVESTMENTS: BREITLING, PETCO, PREMIERSHIP RUGBY

NOTABLE INVESTMENTS: DUNLOP, FREEPIK, KUONI GROUP / VFS GLOBAL

FOUNDED: 1994 NOTABLE INVESTMENTS: APPLAUSE, FINASTRA, SOLERA, VIVIDSEATS

FOUNDED: 1985 NOTABLE INVESTMENTS: REFINITIV, MERLIN ENTERTAINMENTS, GATES CORP

NOTABLE INVESTMENTS: COBHAM, NIELSENIQ, HERMES, LAIRD LIMITED

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.

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PRIVATE INVESTMENT AND INNOVATION It is no secret that some of the most exciting companies around today are private. Businesses choosing to remain private is nothing new, but in today’s world of rapid technological innovation, many of the world’s most exciting businesses are staying private for longer.

Innovation is often what make private businesses so valuable, with many acting as pioneers in their industries. A host of private companies both new and old place innovation at the heart of their plans, including some visionaries known to be somewhat vocal when it comes to investments. It is clear that the private aerospace industry has taken off in recent years.

Led by the vision of business heavyweights Elon Musk, Jeff Bezos and Richard Branson, SpaceX, Blue Origin and Virgin Galactic have all made important forays into chartered space flights.

SpaceX Founder and CEO Elon Musk has been the architect of an attractive business through the firm’s innovation and lofty ambitions, including a successful mission to transport two astronauts to the International Space Station (ISS) in May 2020, and the aim to crew a mission to Mars by 2024.

Innovation is arguably what makes the company such an exciting prospect. Unlike traditional rockets, those developed

by SpaceX are reusable. Although the firm’s Falcon 9 and Falcon Heavy crafts cost US$62m and US$90m to book, respectively, they can be used as many as ten times, significantly reducing the overall cost.

Although SpaceX was recently valued at US$52bn by Morgan Stanley, Musk has suggested that SpaceX will remain private as the firm’s long-term goals don’t align with the short-term demands of retail investors.

While SpaceX is exciting as it has disrupted the aerospace sector since bursting onto the scene, some private firms in other industries are much more well-established. S.C. Johnson, the global company with a family of household cleaning brands under its umbrella, has grown steadily since being founded in 1886.

Many of its best-known innovations, including the brands Glade and Pledge, were developed in the firm’s Research Tower, in place at its US headquarters since 1950. By being well-established and diversifying its product offering in the long-term, the firm has become a well-respected player in its industry and, in doing so, has built a strong reputation for itself.

Over time, this reputation has led to the S.C Johnson family reaching a net worth of US$30bn, while its household cleaning

products business has an estimated US$10.5bn in annual sales.

The Group’s household products arm is just one branch of the business, but by evolving and innovating over the long-term, it has grown into a global, trusted brand.

Remaining innovative and engaging with consumers are two stumbling blocks that traditional businesses often face and can often separate market leaders from underperformers. In the world of sport, many of the large professional clubs are privately-owned. Although some, particularly in football, have been the subject of supporter-led takeovers by local supporters’ trusts, most are owned and financed by private investors.

However, in a world where European football has a global appeal, owners are exploring innovative ways to widen their clubs’ reach. While remaining private and not selling any of their actual shares, a growing number of the world’s leading football clubs are promoting “fan tokens.”

Fan tokens are described by cryptocurrency website CoinMarketCap as “a form of cryptocurrency that give holders access to a variety of fan-related membership perks like voting on club decisions, rewards, merchandise designs and unique experiences.”

A growing number of the world’s biggest football clubs, including Barcelona, Paris Saint-Germain and Inter Milan now offer fan tokens having partnered with Socios.com, the platform which offers these fan tokens.

With COVID-19 restrictions meaning that supporters were unable to attend games in person, clubs re-focused their efforts on providing enhanced digital experiences to fans to keep them engaged. According to a 2021 report by Stats Perform, 75% of respondents in the sports industry felt that the previous twelve months in the COVID-19 era had given them new insights about engaging fans, while 72% said that their organisation was looking into investing in new technology this year.

Similar schemes have been launched by teams in Formula 1, cricket and esports but there have been negative reactions in some quarters, with supporter’s groups suggesting that if clubs promote unregulated cryptocurrencies to their fans they should also promote education around what is often an investing minefield. Although businesses, not just those in professional sport, are looking to the digital space in which to stay innovative, some plans may be better received by consumers than others.

No two business, though, will follow the same plans and, while there are many eye-catching firms that have gone public, innovation in private companies is equally important.

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