ICG Enterprise Trust plc (LON:ICGT) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report on ICG Enterprise Trust sits behind a disclaimer. What can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. In the UK, because private equity is not a simple asset class, and it should only be looked at by professional / qualified investors. P2 of the report gives all the details.
Q2: You called your piece ICGT’s steps to value-adding portfolio construction. What can you tell us about that?
A2: The company has a focused, multi-stage approach to investing in PE, with a stringent filtering process, which starts with the whole PE market but then narrows down investments to buyouts (a lower-risk business than, say, venture capital – VC) – in developed markets (primarily, in Europe and the US), mainly in the mid-market/larger deals (more likely to be resilient to the economic cycle and with stronger/deeper management teams) and through leading PE managers (with track records of investing and adding value through cycles). In the note, we explore the manager selection in more detail. Having passed all these hurdles, individual opportunities must then meet the company’s defensive growth strategy. The focus is then on how third-party relationships can be leveraged to generate high-conviction investments and managing the balance between this portfolio and high-conviction opportunities. All of this has led to an 11% NAV total return over nine months and more than 200% over 10 years.
Q3: So, tell us some more about what they mean by defensive growth?
A3: In practice, defensive growth means they adopt a bottom-up approach, looking for key business model characteristics that should help an investee company to be resilient through the cycle, rather than adopting a top-down approach through sector or geographical allocation. The type of characteristic it is looking for includes a strong competitive position in a structural growth market, a high level of recurring revenues, high margins, strong cashflows and low customer concentration. This leads to a focus on well-established businesses, rather than early-stage companies, enabling them to analyse performance through the most recent downturn as an indication of future defensiveness. When making fund investments, they look for these characteristics in its other managers too. Again, it wants those with experience and a track record through a downturn to add to its comfort in downside scenarios.
Q4: And has it worked?
A4: I’ll talk about the result first and then what it means in practice. In the early 1990s’ recession, the company reported just a 3% fall in NAV for one year and a rapid accretion every year thereafter. Even in the global financial crisis (GFC), the only annual fall in NAV was 14% (FY’08), which was well below stock market falls. The outperformance in FY’21 to date reinforces the point that PE and they outperform overall markets in a downturn. So, its policy has resulted in better than market performance in each of the last three downturns.
Q5: You mentioned leveraging third-party relationships to generate High-conviction investments. How does that work?
A5: The chart on p6 of our report shows only one sixth of the top 10 underlying holdings was held solely through funds and the vast majority are held as direct investments. It is important to understand that, even though the investment is direct, the opportunity to make such investments is driven from the relationship with the third-party managers. Being invited to invest alongside a manager, especially when it is a global powerhouse, like BC Partners or PAI Partner is not easy and takes considerable active management by ICG Enterprise Trust. In a typical year, the manager will aim to meet its 28 current third-party managers at least quarterly and when deals are announced so it builds a relationship with the manager. The manger wants to know that the company has the expertise to understand complex deals and respond quickly and can add value in its review of the opportunity. It also wants the certainty that finance is there. It all takes a lot of effort but on average such investments have generated returns 5% a year higher than the rest of the portfolio.