HarbourVest Global Private Equity — Accessing global megatrends in private markets

HVPE is a Guernsey-incorporated, closed-ended investment company, listed on the Main Market of the London Stock Exchange since September 2015 (having traded on the LSE’s Specialist Funds Market from May 2010), and included in the FTSE 250 index since December 2015. HVPE was listed on Euronext Amsterdam from its inception in December 2007 until October 2016. HVPE’s share price is quoted in sterling, but its functional currency is the US dollar and it publishes its NAV monthly in both sterling and dollar terms.

HVPE invests in a diversified portfolio of private equity investments, comprising HarbourVest-managed primary and secondary funds of funds and co-investment funds, as well as selected direct investments. HarbourVest is an independent, global private markets investment specialist, with a 35-year track record and over US$40bn of assets under management. HarbourVest’s investment team includes more than 100 professionals responsible for managing a broad range of funds.

HarbourVest funds make investment commitments to leading third-party fund managers across the spectrum of global private equity investment, including venture capital, growth equity and buyout strategies. HVPE’s approach gives investors exposure to a broad range of underlying companies.

Towards the end of 2017, HVPE conducted an in-depth survey of 30 HarbourVest managing directors to identify key investment themes and opportunities in private markets. The survey results highlighted three key global megatrends that are expected to dominate private markets over the next 10 years:

HarbourVest funds are expected to provide HVPE with exposure to many of the opportunities created by these megatrends through the following aspects of HarbourVest’s investment approach:

Reflecting on the 10 years since its launch in December 2007, HVPE highlights some of the most significant investment themes, including:

Each year, HVPE’s investment manager plans the new commitments to be made to HarbourVest funds over the following 12 months, seeking to optimise long-term returns for HVPE shareholders. The total commitment level is based on forecast cash flows and investment returns, while fund allocations are determined with reference to HVPE’s strategic asset allocations, which were revised in February 2018 to reflect the recent strong performance of direct co-investments and the appeal of the somewhat uncorrelated returns provided by mezzanine and real assets. These comprise a set of rolling five-year portfolio construction targets by investment stage, geography and strategy, as a proportion of NAV. The targets take into account macroeconomic and geopolitical factors, the available opportunity set, historical performance and HarbourVest’s specific areas of expertise.

HVPE’s approach is to maintain a consistent rate of investment, which ensures a broad spread of fund vintages are held in the portfolio. The fund-of-funds structure enhances this approach, as commitments made by HVPE to HarbourVest funds are allocated over three to four years to third-party managers, who invest in operating companies over the following three to five years.

HarbourVest conducts extensive due diligence before investing with third-party managers. Primary commitments are made to funds at launch, taking into consideration the fund manager’s investment skills, leadership and track record, the fund’s investment focus and strategy, contractual terms, fund size, expected duration, exposure limits and fees. For secondary assets (whole or part portfolios of maturing investments), a bottom-up valuation of portfolio companies is completed, and the capabilities of the underlying fund manager assessed. Direct investments – usually coinvestments alongside managers of underlying portfolio funds – typically arise from HarbourVest’s strong relationships with leading managers. Around 100 of these opportunities are reviewed in depth each year, with a proprietary database maintained covering 20 years of transactions.

HVPE’s portfolio comprised 42 HarbourVest funds and two secondary co-investments at end-February 2018, giving exposure to c 900 underlying private equity funds and partnerships, which are invested in over 7,500 operating companies. Exhibit 2 shows HVPE’s portfolio exposure at end-February 2018, and illustrates the broad diversification by geography and industry. Compared with end-February 2017, US exposure has declined by 8pp, mainly offset by 4pp and 3pp increases in exposure to Asia Pacific and Europe. These changes would be expected to reverse over the medium term, as the portfolio moves closer to the geographic strategic allocation targets, last revised in November 2016 (US 65%, Europe 18%, Asia Pacific 12%).

HVPE has provided a more detailed industry exposure analysis of the portfolio since October 2017 and, while it is not possible to make a direct comparison of the end-February 2018 exposures with a year earlier, the overall exposures appear broadly similar. Over the four months to end-February 2018, the most significant changes in exposure were a 3pp decline in media and telecom and a 2pp increase in tech & software, with no other changes in industry exposure of more than 1pp.

Exhibit 3 shows HVPE’s portfolio profile by stage, phase, strategy and currency exposure. Compared with a year earlier, there have been relatively modest changes in portfolio exposures, the most significant being an 8pp reduction in mature phase exposure, offset by 6pp and 2pp increases in the investment and growth phases, reflecting the natural realisation of mature investments, with proceeds being drawn down for new investments. Similar to the geographical exposures, the investment stage and strategy exposures are expected to shift over the medium term, as the portfolio moves closer to the current strategic allocation targets, revised in February 2018 (buyout 60%, venture and growth equity 30%, mezzanine and real assets 10%; primary 55%, secondary 25%, direct 20%). Over the year, there was a 2pp decline in US dollar exposure, but this remains by far the dominant currency exposure in the portfolio.

HVPE’s investments are principally denominated in US dollars (the company’s functional currency), while NAV is reported in US dollars and sterling, and the share price is quoted in sterling. In US dollar terms, HVPE’s NAV total return was 15.7% for the year to end-February 2018, which is higher than the returns achieved in each of the prior three financial years. However, as illustrated in Exhibit 4, in sterling terms, HVPE’s NAV total return over one year was much more modest, underperforming its FTSE All-World benchmark by some margin. In contrast, HVPE’s NAV total return over three, five and 10 years has been ahead of its listed equity benchmark, with HVPE’s 11.6% pa NAV total return over 10 years comparing to its blended benchmark’s 10.2% pa return.

As illustrated in Exhibit 6, after broadly matching its benchmark performance from early 2013 to mid-2015, the second half of 2015 and early 2016 saw HVPE substantially outperform, largely reflecting global equity market weakness during this period, with HVPE’s NAV holding fairly steady. The subsequent weaker relative performance reflects the sustained rally of global equity markets, with HVPE’s NAV progressing higher at a more measured pace over this period.

Exhibit 7 compares HVPE’s share price and NAV returns in US dollars and sterling. Sterling weakened versus the dollar in 2016, influenced by the UK vote to leave the European Union, continuing the long-term trend evident since the fund’s inception. However, 2017 and early 2018 saw a significant recovery in sterling, and the exchange rate was US$1.38/£ at end-February 2018 compared with US$1.24/£ a year earlier. This 10.7% appreciation of sterling has weighed significantly on returns for sterling investors over one year, although sterling returns have been enhanced by currency moves over longer periods.

The board regularly reviews HVPE’s share price discount to NAV and considers actions that might help to reduce it over the longer term. However, the board’s overriding view is that investment performance and market sentiment towards listed private equity as an asset class are the key drivers of the discount. While HVPE has authority to repurchase up to 14.99% of its issued share capital, no shares have been repurchased in the last three financial years.

As illustrated in Exhibit 8, HVPE’s discount narrowed substantially from its five-year wide point of 33.7% at the end of June 2016 (shortly after the UK’s vote to exit the European Union) to its five-year low of 9.6% in May 2017, since when it has widened moderately. The current discount of 18.8% is wider than its 16.0% one-year average, but narrower than its 19.7% and 20.7% averages over three and five years.

HVPE has a single share class, with 79.9m ordinary shares in issue, listed on the Main Market of the London Stock Exchange. HVPE has a US$500m multi-currency credit facility with Lloyds Bank and Credit Suisse, which was renewed in December 2017 and extended to five years’ duration, maturing in December 2022. The commitment fee on the undrawn facility is unchanged at 115bp, while borrowing costs have been modestly reduced to Libor plus 275bp up to US$250m, moving to Libor plus 300bp if borrowings exceed US$250m. HVPE has maintained a net cash position since August 2014, and has not drawn against the current credit facility. As at end-February 2018, HVPE held US$246.9m in cash, equating to 14.8% of net assets.

HVPE is one of the largest investors into the HarbourVest platform, and typically pays the lowest fee rates on new commitments to HarbourVest funds. In FY17, total management fees represented 1.08% of HVPE’s net assets. This excludes fees paid by HarbourVest funds to the underlying third-party managers, which are deducted from underlying fund-level returns and not separately reported. HVPE’s recurring operating expenses in FY17 totalled 0.65% of net assets, and carried interest payments (performance fees) on the HarbourVest secondary and direct co-investment funds, along with HVPE’s two direct co-investments, amounted to 0.51% of net assets. No performance fee is charged by HVPE itself. Net of interest income, HVPE’s FY17 total expense ratio was 2.17%.

In accordance with its capital growth mandate and reflecting the capital nature of private equity returns, HVPE has not paid a dividend since its launch. Two US$20m special distributions were made in FY14 and FY15 (see Exhibit 1), following the realisation of HVPE’s direct co-investments in Absolute and Conversus, representing 50% of the profits on these transactions.

Exhibit 9 shows a comparison of HVPE with six other AIC Private Equity sector funds that have a fund-of-funds structure. In sterling terms, HVPE’s NAV total returns are ahead of the peer group average over five and 10 years, ranking first in both periods, in line over three years and below the average over one year. As highlighted earlier (see Exhibit 7), HVPE’s one-year NAV total return was 15.7% in its US dollar functional currency, and the 10.7% appreciation of sterling against the dollar has weighed heavily on its performance in sterling terms. HVPE’s 18.8% discount is the widest in the peer group, which has a relatively narrow range excluding F&C Private Equity Trust. HVPE does not pay a dividend and, similar to peers, it is ungeared, holding net cash to meet its investment commitments. HVPE’s ongoing charge is higher than the peer group average, possibly reflecting its ‘fund of fund of funds’ structure. However, excluding performance fees on the HarbourVest secondary and co-investment funds and on its two direct co-investments, HVPE’s 1.66% ongoing charge is only modestly above average.

HVPE has eight board directors, six of whom are independent. Chairman Sir Michael Bunbury has served on the board since October 2007, shortly before HVPE’s launch in December 2007, as have Andrew Moore, Jean-Bernard Schmidt, Keith Corbin and Brooks Zug. Alan Hodson and Peter Wilson were appointed in April and May 2013 respectively, and Francesca Barnes joined the board in April 2017. Brooks Zug, a founder and senior managing director of HarbourVest, and Peter Wilson, a member of HarbourVest’s executive management committee, are non-independent. The other directors have backgrounds in financial services, investment management and private equity. Five directors have served for over 10 years and the chairman has indicated that further new appointments to the board should be expected in due course.