Listed Private Equity: A Renaissance Ahead?
By Erik Jamieson
Historically, direct investment into private equity and private equity funds has been difficult for the retail investor. Large lot sizes, complicated legal documentation and regulatory restrictions on fund promotions have combined to limit access to even the best performing private equity funds. Seemingly as a retail investor you can only make money from private equity if you have enough money to lose. The direction of new regulation is reinforcing this trend. The Alternative Investment Fund Directive (“AIFMD”) introduces a passport for the easier promotion
of alternative Funds throughout the EU – but only to institutional investors, not to the retail public. In a number of EU countries, including the UK, implementation of the AIFMD has been accompanied by the introduction of further restrictions on the sale of alternative investment funds to the retail public. In the UK these new restrictions can be found in the so-called “NMPI Restrictions” – which ban the promotion by FCA regulated private client wealth managers of all “non-mainstream pooled investments” to retail investors.
Whilst it has become increasingly difficult for investors to access private equity funds directly, there has been considerable growth over recent years in the listed private equity fund market. It is estimated that there are currently some 250 listed vehicles worldwide offering investors indirect access to private equity without the restrictive lot sizes
and illiquidity that accompanies direct investment in private equity through a typical private limited partnership structure. Investors now have a choice from a wide spectrum of listed funds that offer varying investment strategies defined by target company size, geography, and industry focus as well as stage of development. These vehicles include a choice not only of indirect investment into private equity but also the ability to access funds of funds and hybrid vehicles and even the chance to gain an exposure to the managers themselves. Listed funds are often particularly attractive to managers because they provide a core of permanent or semi-permanent capital and reduce the burden of regular rounds of fundraising.
The AIFMD is now imposing a greater regulatory burden on these vehicles and the benefit of the EU passport allowing for the EU-wide circulation of Prospectus Directive compliant prospectuses will no longer apply. The (comparatively) good news, however, is that the NMPI Restrictions will not apply to any of these listed funds that are investing directly into private equity shares, or to the extent that they qualify as listed investment trust companies (or would so qualify if they were resident and listed in the UK) and hence many of these vehicles can continue to be promoted to retail investors in the UK.
Whilst the direction of the market and the regulations may be indicative of a growing acceptance of listed private equity funds, some of the historic difficulties remain. In particular, the liquidity offered by listed funds is sometimes illusory and whilst discounts to net asset value have been narrowing recently they are still a significant problem in the market with average discounts still at over 10%. Furthermore, compared to traditional limited partnership models with a gradual drawdown structure, listed funds are likely to suffer cash drag.
However, there are also clear benefits to be seen; for example, listed funds complying with stock exchange rules concerning the composition of the Boards of Directors and associated corporate governance requirements are often more aligned with the requirements of today’s investor. Likewise, AIFMD also reinforces the move to greater transparency and investor reporting that has long been a requirement for listed funds. Listed funds are typically structured as companies rather than limited partnerships and this too brings with it certain benefits but also certain disadvantages. On the one hand the process of buying and holding shares in a company requires no complicated explanation and legal documentation that is often seen with private limited partnership structures; and the governance, reporting and operating structures within a company will be familiar to all.
On the other hand, depending on where a company is incorporated, there may be requirements, for example, relating to the payment of distributions, or the return of capital which may not always sit easily with a fund’s ideal investment objective. For example to qualify as an investment trust company under English law, no more than 15% of the Company’s income may be retained in any year, which may make it difficult for a manager seeking to re-invest dividends rather than pay them on to shareholders.
So, in conclusion we have seen a growth in the number of listed private equity vehicles available to investors in recent years. The direction of the new regulations suggests this growth may well continue and, in particular, once discounts narrow further, it may increasingly become the preferred option for private equity managers seeking to raise money from retail investors.
Erik is a Partner in Hogan Lovells investment funds team based in London. Erik heads up the listed funds group and has been particularly active acting for both issuers and underwriters on many of the recent London main market listings of infrastructure and renewables funds. Erik has established private equity funds, infrastructure funds, country funds, and hedge funds for his clients. Erik has experience of listings on the main market of the London Stock Exchange, the Specialist Fund Market, AIM and the Irish and Channel Islands exchanges. Erik is recognised as a leading lawyer by Chambers & Partners, Legal 500 and other legal directories.