Pantheon International Analyst Q&A: Delivering market-beating, post-cost returns since inception (LON:PIN)

Pantheon International plc (LON:PIN) 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 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, PE is seen as a complex investment, and the report is targeted at professional/qualified investors.

Q2: So, you called your note “The real costs of public vs. PE ownership”. What can you tell us about it?

A2: In this note, we use some high-profile, mainly hostile, bid situations to illustrate the “agency” costs that can be a material drag on the performance of a listed equities portfolio.

The strong corporate governance embedded in PE means it does not incur such costs, allowing i) a long-term focus (with a through-cycle perspective), ii) shorter periods of operational underperformance, iii) reduced risk of non-financially motivated acquisitions, and iv) aligned managers’ and shareholders’ interests.

While PE is resource-intensive, we demonstrate how Pantheon International avoids agency costs – a material factor in it delivering market-beating, post-cost returns since inception.

Q3: Why do you see fees as an issue?

A3: PE fees are an issue for some investors but, in this report, we try to put them into a proper perspective, and compare the real costs of public and private portfolios.

Investors must focus on doing a truly like-for-like comparison. There are some costs, such as listing/investor relations expenses that are quite obvious and included in the annual accounting numbers.

However, we believe much more significant and opaque are the costs arising because the diffuse shareholding base of public companies separates ownership from control, and investors’ interests are not always aligned to company managers. They are sometimes referred to as agency costs , as managers have become the agents for the shareholders.

Q4 : So, can you give us a brief summary of some of the most important agency costs?

First, the short-term focus – in public companies, management may manage earnings in order to meet analyst forecasts and maintain smooth earnings as a signal to the market that all is well.  Additionally, managers’ performance bonuses, or prices of options, may be driven by short-term operational or share price performance. This can lead to deferring investment, reducing marketing spend, accelerating revenue recognition and other accounting assumption changes.

Second, there is sustained underperformance – we believe public companies, without the direct influence of active owners, are more likely to face agency costs like “soft budget constraints” and “pet projects”, leading to extended operational underperformance. This may, in part, come from a focus on the short term. The crucial question to answer is why such underperformance is allowed to continue by both public shareholders and boards.

Third, we highlight how acquisitions are value-destroying in aggregate for public companies but a core competency in PE. In 1991, the Finance Director at NatWest told this analyst, with a huge sigh, “When they talk strategy, I have to reach for my chequebook”. It reflects the fact that financial returns are not always the key driver to acquisitions – a view we believe to be prevalent across many public companies.

Fourth, we highlight non-performance-related remuneration – the lower level of shareholders’ involvement may see remuneration biased away from bottom-line performance onto other metrics, to the detriment of long-term investor returns. In addition, there is the risk that listed companies benchmark remuneration against what their peers pay, rather than the performance of the company.

Pantheon International is a listed FTSE 250 private equity investment trust, overseen by an independent Board of Directors and managed by Pantheon, one of the leading private equity investment managers globally.

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