HarbourVest Global Private Equity — Diverse and selective

HVPE reported half-year results to the end of July on 18 October.

As highlighted above, the uplift on realisations compared with carrying value has remained substantial. The next two exhibits provide a longer-term perspective on commitments and cash investments and distributions from funds. As a reminder, HVPE invests through a three-tier structure with its investment commitments made to specific HarbourVest funds, which make commitments to a number of partnerships over three or four years that in turn invest in operating companies over three to five years. HVPE aims for a balance in the portfolio, with approximately 25% in both investment and mature categories and 50% in the growth phase (between five and 10 years from initial capital call for primary funds).

Exhibit 3 gives a view of the progression of HVPE investments by tracking commitments and the subsequent cash outflows and inflows. Unsurprisingly, there is some lumpiness in timing between the different periods, reflecting the incidence of appropriate opportunities at each stage and the need to maintain balance in the portfolio. Looking at the averages shown in the last set of columns, the three metrics are more closely aligned than for several of the individual periods as the pace of commitment, cash investment and realisation even out over time.

Exhibit 4 illustrates how the level of commitments has been managed to maintain exposure and financing coverage within a range. The commitment level is calculated as the total value of the investment portfolio and investment pipeline divided by the net asset value and gives an indication of HVPE’s total exposure to the private equity market. This is used as a measure of capacity for additional commitments to HarbourVest funds and co-investments. The coverage ratio shown is the level of cash and available credit facility as a percentage of the investment pipeline (including both allocated and unallocated commitments). This is a commonly used indicator of balance sheet risk; HVPE highlights that its investment cycle is longer than many quoted peers meaning that it requires a relatively high level of unfunded commitments to remain fully invested; its coverage ratio (latest value 51%) may therefore appear relatively low while not necessarily posing a greater risk. An alternative ratio given by HVPE that measures the medium-term exposure adds estimated realisations in the current year to cash and credit available and divides this by estimated investments over three years; at end-September, this ratio stood at 77%.

In the following three exhibits, we collate HVPE disclosure on the portfolio positioning on five criteria: investment stage, geography, strategy, year of investment and industry. On page two, there are charts showing the split of funds by currency of denomination (79% US dollar) and an analysis of the investment pipeline by vintage (48% one to three years).

In Exhibit 5, we include the last reported portfolio position and the company’s five-year rolling strategic asset allocation targets (last revised in February 2018). This shows the predominance of buyout, US and primary investments, which in turn broadly mirror the overall profile of the global private equity industry. Looking at the portfolio position compared with the allocation targets, the two more obvious differences are that the US and primary exposures are below target. The US underweight in part reflects the strong performance of Asia Pacific investments, and HVPE aims to increase the US weighting over the five-year target period. Similarly, the below-target position in primary strategies (investment in initial fund offerings) reflects strong performance in funds making secondary purchases and direct co-investments. HVPE notes that it still sees primary as core to its strategy, as it gives access to managers with strong records whose funds are less likely to be available on the secondary market. It will therefore also seek to move towards the target allocation here. A final note on this analysis is that the mezzanine and real assets weighting had increased by two percentage points to 10% since the end of FY18 and, in order to increase exposure to assets less correlated with the broader macroeconomic cycle HVPE, committed $150m to a new HarbourVest fund in this area, where it is a seed investor and will benefit from a share in management fee income.

The analysis in Exhibit 6 shows one measure of time diversification in the portfolio. While the chart on page two shows the vintage of commitments in the investment pipeline, this illustrates the weighting of the existing portfolio by year of initial investment in underlying operating companies. Here, the weighting to the latest five years at 65% has increased compared with 59% at the same point last year, giving the portfolio a modestly younger profile following a year of relatively high cash realisations in FY18 (see Exhibit 3).

In the industry analysis (Exhibit 7), tech & software is comfortably the largest sectoral exposure and this has increased from 20% in October 2018, countered by a reduction in media & telecom from 9% to 5%. The manager has noted that shifts in the technology landscape over the next 10 years are likely to be a salient investment theme (along with demographic changes and a growing global role for China) and sees its access to, and selection of, well-regarded managers as an important capability in this sector. Comparing the industry exposures with a public market index, MSCI World, the sectoral classification is not the same but, where they broadly overlap, the technology exposure is lower in the index (19%), as is healthcare (12% versus 15% for medical & biotech at HVPE). The index exposure to financials is higher than HVPE’s at 16% compared with 12%.

In HarbourVest’s commentary on the private equity market background, key themes in the US are a focus on generating liquidity (exits) in the buyout market and continued growth in the levels of undeployed capital in both buyout and venture markets. The high level of this dry powder is also a feature outside the US and is contributing to historically high valuations that pose a challenge for managers (McKinsey’s 2018 private equity sector report indicated a global median EV/EBITDA of 10.7x for acquisitions in 2017, a 10-year high). In response, managers are engaging in more complex transactions, more formal profit improvement plans, and buy and build strategies. In Europe, public market volatility has contributed to fewer IPO exits and, with fewer M&A exits, an overall decline of 39% in exits was seen in the first half of calendar 2018.

Looking ahead, equity markets have recently seen an increase in volatility but still remain close to highs, with macro uncertainties a potential source of further corrections that would have a read across to private equity pricing. Against this, the private equity investment cycle is relatively long term and HVPE’s approach of consistent investment over time moderates the impact of fluctuating pricing, for example, while seeking to extract value through access to and selection of underlying managers.

At a discount of 22.7% to net asset value, HVPE shares are trading at a level that is wide in absolute terms and slightly above the average levels for one, three and five years (19.8%, 20.7% and 20.6%, respectively). Exhibit 8 shows that the discount drifted wider between January and July 2018, perhaps in response to a flat NAV return in sterling terms in the second half of FY18, and the strength of first half-FY19 performance could support a continuation of the recent discount narrowing. As noted in the next section, the current discount is also above the average for a peer group of fund of funds.

In our peer comparison (Exhibit 9), we include six other members of the AIC Private Equity sector that also have a fund of funds structure. The total returns are in sterling terms and HVPE is ahead of the peer group averages over one, three, five and 10 years. It has the second highest discount to NAV in the group at over 22%, with two other companies trading at discounts of over 20%. The ongoing charge is at the upper end of the range within the group.