The benefits of combining public and private equity investments

Schroder British Opportunities was launched December 2020 in response to the Covid-19 pandemic – the genesis being what the managers describe as a “once in generation opportunity to buy really great quality UK small and mid-cap companies.” Investing in both public and private equity, they were searching for companies that weren’t distressed in terms of debt, but that needed fresh equity injected for them to realise their full potential.

Here, co-managers Rory Bateman and Tim Creed explain what they believe to be the merits of a public-private equity investment approach and their views on the attractiveness of the UK market today.

The benefits of combining public and private equity investments

“Both public and private equity investments can be attractive as standalone strategies,” said Rory. “However, we believe bringing them together in the same portfolio confers some important benefits. These include access to a broader set of potential investee companies, the ability to invest at an early stage in a company’s existence, as well as enabling a wider perspective and consistency of stewardship.”

Achieving greater diversification

“Stock markets in different geographies have different degrees of diversification,” continued Rory. “In the UK, for example, the tech sector represents only c.1.4% of the MSCI UK index compared to nearer 30% for the MSCI US (as at end of 2021).

“But that doesn’t mean there are no attractive tech companies in the UK, just that they aren’t publicly listed. Fast growing segments such as fintech (financial technology) can be accessed by private equity investors.

“Therefore, a portfolio that combines both public and private equity investments can invest in the best opportunities from either segment of the market.”

More information, better research

“Private companies often provide their investors with more information than public ones do, given the strict reporting rules that apply to stock market listed firms,” continued Tim. “Information from a private company can therefore help shed light on a public company operating in the same field; for example, on industry issues such as competition or demand trends.

“This can be particularly useful when assessing the attractiveness (or otherwise) of niche areas of the market.”

Investing through a company’s lifecycle

“An integrated public-private equity approach also offers the opportunity to invest at all stages of a company’s lifecycle,” Tim added. “This could be from the venture capital stage, through subsequent funding rounds, to a stock market listing, and beyond.”

“Of course, not all companies seek a listing on the stock market,” said Tim. “However, if this is a company’s ambition, investors who can invest in the company at an early stage are often able to do so at a lower valuation than the eventual IPO price. This potentially provides such investors with a superior ability to outperform relative to other public equity investors who enter at a higher price.

“What’s more, we have found that IPO candidates often seek out long term financial partners early on, with a mutual understanding that these partners may act as cornerstone investors for the listing. Our experience is that companies with an end goal to IPO are more likely to select investment firms that have internal capacity also to invest in the public equity markets.

“Building a relationship in earlier funding rounds can therefore be an important competitive advantage for those who have the capacity to invest across the whole company lifecycle.”

Tackling ESG issues early on

“The relationship building made possible by investing at an early stage can also be beneficial when it comes to stewardship and environmental, social and governance (ESG) issues,” said Tim.

“Companies in an early phase of their lifecycle may have limited sustainability policies and infrastructure. By investing early, before such companies reach the public markets, public-private equity investors can drive significant change through partnership on ESG issues. This could include implementing diversity & inclusion and environmental practices at an early stage and recommending an appropriate board structure.”

Opportunities in the market today

“We think it’s important to member that a sizeable valuation discount has existed between the UK and global indices for close to two decades – both large and mid/small caps have been trading lower than their peers across multiple sectors. And there is no reason we can see for this other than that the UK market is out of favour,” said Rory.

“While UK large caps may well continue their outperformance for now versus small caps, due to the value-oriented composition of the FTSE 100 index, we still believe there is scope to invest opportunistically in small- and mid-sized companies. Many smaller companies’ share prices have fallen disproportionately due to the recent flight from riskier assets, despite no change to their fundamentals.

“What’s more, while UK stocks are lowly valued compared to global peers, they are also highly cash generative. We believe that this combination presents a very compelling investment opportunity.”

In this podcast, Rory, and UK small and mid-cap analyst Uzo Ekwue, tell us more about the opportunities they are aiming to exploit and give examples of the high growth and undervalued UK companies they are targeting: