LPEQ — Outperforming through market uncertainty

LPE sector performance

Outperforming through market uncertainty

Financials

20 February 2018

Analysts

Robert Murphy	+44(0)20 3077 5733
Gavin Wood	+44(0)20 3681 2503

financials@edisongroup.com

This report has been commissioned by LPEQ Ltd
www.lpeq.com

Investors in European-listed private equity (LPE) have been presented with two sources of uncertainty recently: disclosures in the new key information documents (KIDs) required under MiFID II and increased market volatility. In the 12 months to 9 February 2018, however, the LPX Europe Total Price Return Index (LPX) of major UK and European LPE companies returned 16% compared to 8% for the MSCI Europe index. Over the same period, the LPX total NAV return was even higher at 18%. Over 10 years the LPX returned 119% compared to 93% for MSCI Europe. Thus, LPE has continued to deliver impressive net-of-fee returns for investors.

Confusing KIDs?

The release of KIDs at the beginning of this year has been a source of confusion and uncertainty for investors in closed-end funds. In particular, performance scenario methodology using five-year data has resulted in positive projections of returns in ‘unfavourable’ scenarios and anomalous differences between individual companies. Fee disclosures have also put LPE in an unfavourable light. Indeed, the Investment Association called for an ‘urgent’ review of KIDs on 25 January. The key focus for investors, of course, should be net returns over the cycle.

LPE outperformed in the recent sell-off

The recent increase in equity market volatility was sharp but by no means unprecedented and occurred against a supportive economic backdrop. Perhaps surprisingly, the LPX slightly outperformed MSCI Europe in the three weeks to 9 February 2018 and has outperformed by 7%, 40% and 13% over the last one, five and ten years respectively.

LPE continues to deliver impressive returns

LPE has performed well over the last year. In the year to 9 February 2018, the LPX returned 16% compared to 8% for the MSCI Europe index. Over the same period, the LPX total NAV return was even higher at 18%. Private equity, and by implication LPE, is a long-term asset class, however, and we would argue investors should look through periods of market volatility and focus on net returns over longer investment horizons. Over 10 years the LPX has returned 119% versus 93% for MSCI Europe. The NAV net return was strong but slightly below the index at 76% over this period due to unfavourable comparatives which should improve as we have discussed in previous notes. Thus, LPE has continued to deliver attractive net-of-fee returns for investors.

LPE: Outperforming through market uncertainty

Investors in European-listed private equity (LPE) have been presented with two sources of uncertainty recently: disclosures in the new key information documents (KIDs) required under MiFID II and increased market volatility. Investors appear to have taken these uncertainties in their stride with the LPX returning 16% over the 12 months to 9 February compared to 8% for MSCI Europe. Over the longer term, LPE has continued to outperform as the LPX returned 119% compared to 93% for MSCI Europe over the last 10 years.

Confusing KIDs?

The release of KIDs at the beginning of this year has been a source of confusion and uncertainty for investors in closed-end funds. In particular, the performance scenario methodology using five-year data has resulted in positive projections of returns in ‘unfavourable’ scenarios and anomalous differences between individual companies. Fee disclosures also generally put LPE in an unfavourable light when taken in isolation from returns. Indeed, the Investment Association called for an ‘urgent’ review of KIDs on 25 January. The key focus for investors, of course, should be net-of-fee returns over the cycle. Thus, focusing on short-term performance figures and fees in isolation from net returns does not make sense.

We present NAV returns which are all net-of-fees for the LPX in Exhibit 1. We can see that the LPX has strongly outperformed both the MSCI Europe index by 9%, 20% and 14% over one, three and five years and the FTSE All-Share index by 15% 32% and 27%.

Absolute NAV performance has been solid at 76% over 10 years but has trailed the major indices due to unfavourable comparatives which should improve, as we have discussed in previous notes.

Exhibit 1: NAV performance
(£)	One year	Three years	Five years	10 years
LPX Europe NAV	17.8%	55.8%	78.8%	75.8%
MSCI Europe	8.4%	29.8%	57.0%	93.4%
LPX NAV relative to MSCI Europe	8.6%	20.0%	13.9%	-9.1%
FTSE All-Share	2.5%	18.2%	41.4%	89.4%
LPX NAV relative to FTSE All-Share	14.9%	31.8%	26.5%	-7.2%

Source: Bloomberg, Edison Investment Research

LPE outperformed in the recent sell-off

The recent increase in equity market volatility was sharp but by no means unprecedented and occurred against a supportive economic backdrop. Using weekly data we take the performance from the recent weekly peak and trough (a three-week interval) of the relevant indices with the results shown in Exhibit 2.

Exhibit 2: The sell-off performance
	Weekly peak	Weekly trough	Change
(£)	19 January 2018	9 February 2018	(%)
LPX	841.3	789.5	-6.2%
MSCI Europe	170.9	159.1	-6.9%
LPX relative to MSCI Europe			0.8%

Source: Bloomberg, Edison Investment Research

The LPX fell 6.2% compared to a 6.9% decline in MSCI Europe and perhaps surprisingly, outperformed by 0.8% in the three weeks to 9 February 2018. This might be explained by the market expecting continued strong NAV performance for LPE given the positive economic growth environment both in Europe and globally.

LPE continues to deliver impressive returns

We highlight performance data for the LPX in Exhibit 3.

Exhibit 3: Price performance
(£)	One year	Three years	Five years	10 years
LPX Europe	15.5%	67.9%	120.3%	118.9%
MSCI Europe	8.4%	29.8%	57.0%	93.4%
LPX price relative to MSCI Europe	6.5%	29.3%	40.3%	13.2%
FTSE All-Share	2.5%	18.2%	41.4%	89.4%
LPX price relative to FTSE All-Share	12.7%	42.0%	55.8%	15.6%

Source: Bloomberg, Edison Investment Research

As the table shows, LPE has performed well over the last year. In the year to 9 February 2018, it returned 16% compared to 8% for the MSCI Europe index and only 2.5% for the FTSE All-Share. In addition, over three and five years the LPX has hugely outperformed the major indices by between 29% and 56%.

However, private equity, and by implication LPE, is a long-term asset class and we would argue that investors should look through periods of market volatility and focus on net returns over longer investment horizons.

Over 10 years the LPX has returned 119% compared to 93% for MSCI Europe and 89% for the FTSE All-Share equivalent to outperformance of 13% and 16% respectively.

The reason for the outperformance is the narrowing discount, as we showed above that the NAV return has lagged the indices somewhat. We illustrate the development of the LPX discount below.

Exhibit 4: LPX Europe price index

	February 2018	One year	Three years	Five years	10 years
NAV premium/discount	-6.6%	-5.8%	-11.3%	-23.9%	-19.3%

Source: Bloomberg, Edison Investment Research

The NAV discount of 19% ten years ago illustrates that the market was most likely expecting a much weaker return outcome than was actually delivered by LPE over the subsequent 10-year period.

Comparatives to remain supportive in future

Exhibit 5: LPX total return relative to MSCI Europe (£)

Source: Bloomberg, Edison Investment Research

The LPE sector is gradually leaving behind the negative effect created by a handful of companies that made missteps during the financial crisis, as shown in Exhibit 5 above. In fact, the sector ought to begin to benefit from a significant tailwind to rolling 10-year returns in future as comparatives improve.

We update our projection of rolling 10-year relative returns in Exhibit 6 below. Assuming flat markets going forward, one can see that LPX relative returns should actually improve strongly into the high, double-digits in the next three years. This should continue to support and improve the perception of the LPE asset class.

Exhibit 6: Price performance

(£)	February 2018	February 2019	February 2020	February 2021
LPX Europe price	118.9%	419.7%	211.7%	128.4%
MSCI Europe	93.4%	151.5%	101.0%	67.9%
LPX price relative to MSCI Europe	13.2%	106.7%	55.1%	36.0%
FTSE All-Share	89.4%	149.1%	95.6%	58.7%
LPX price relative to FTSE All-Share	15.6%	108.7%	59.4%	43.9%

Source: Bloomberg, Edison Investment Research

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United Kingdom

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Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

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10017, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

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NSW 2000, Australia

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