Listed Funds: Will 2008 be their year?

Date: Friday, December 21, 2007
Author: SJ Berwin, Victoria Younghusband, AltAssets.com

Much ink has been spilt on the subject of listed private equity funds during 2007. As some funds decided to access permanent capital on Europe's stock markets, London tried to attract more of that business from Amsterdam and many predicted a stampede to list, writes Victoria Younghusband of SJ Berwin. More difficult market conditions and falling share prices among some of those newly quoted funds knocked the trend sideways - leaving some arguing that the traditional private model would continue to dominate private equity fund structures, and that other alternative asset classes might be more profitable targets for stock markets eager to attract business.

Of course, the reality is that both listed and unlisted vehicles have their place in the private equity universe - and have done for many years.

So London has rightly pressed ahead with its reforms. Last Friday, the Financial Services Authority - the UK's super-regulator - completed its review of the UK's listing regime for investment entities and published a policy statement. From 6 March 2008, when the final amendments to the relevant chapter of the Listing Rules come into effect, the new more "principles-based" regime - which removes most of the obstacles to listing alternative investment entities - will be in place. This should enable Private Equity Investment Trusts (PEITs) to open up private equity further to retail investors.

PEITs are closed-ended investment companies traded on the main market of the London Stock Exchange. In all, they have a market capitalisation of around £10 billion (€14 billion). Traditionally PEITs were formed as UK "investment trusts", with privileged tax status (an exemption from UK tax on their capital gains) but subject to the quite onerous qualifying restrictions, including a prohibition on investing more than 15% of total assets in any single company or group and on distributing capital profits. Many long established private equity funds have taken this form but, in part to avoid the restrictions, the more recent PEITs have been companies incorporated in offshore tax exempt jurisdictions, usually in Guernsey (and so are not UK "investment trusts").

Some PEITs are funds of funds, which invest in a portfolio of limited partnerships, whilst some invest in a portfolio of companies selected by their manager alongside limited partnership funds managed by the same manager, and some are hybrids. PEITs are not to be confused with Venture Capital Trusts (VCTs), which offer targeted tax advantages to individual investors but must follow stringent regulations as to the size and nature of the companies in which they can invest. Nor would they be eligible for the London Stock Exchange's new Specialist Funds Market (a regulated market that does not impose the "super-equivalent" requirements of chapter 15 of the Listing Rules) as the target investor for that market is specifically institutional, professional and highly knowledgeable investors, and not the retail market generally.

The Initiative for Private Equity Investment Trusts (iPEIT) was launched in September last year with the aim of raising awareness and increasing understanding of what PEITs are and how they enable all investors, and not just large institutions, to invest in private equity. iPEIT members comprise a group of 10 big name trusts, including Electra, F & C, Graphite, Hg Capital, New Star, Pantheon and Standard Life.

Whilst the objective of PEITs generally is to provide long term capital growth, a number of PEITs now also offer a competitive dividend stream. The performance graph showing the performance of PEITs over 10 years speaks for itself in terms of out-performance in relation to the FTSE All Share index total return. So, the attraction is clear for retail investors. For private equity managers, the attraction is a permanent capital vehicle that may (subject to review by the independent board of directors) invest either in or alongside private funds that it manages. The disclosure and corporate governance requirements that a listed vehicle has to comply with should also deflect some of the criticism of opaqueness and complexity that the industry has had to contend with.

So, perhaps - with a new regime in London, and a growing desire to access a deep and permanent pool of capital - PEITs can look forward to a strong 2008. Whether market conditions and investor sentiment will facilitate that is, of course, the big open question.

SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. For more information go to www.sjberwin.com or contact Victoria Younghusband (victoria.younghusband@sjberwin.com).