There are signs of an "impending" recovery for private equity exit activity, potentially offering investment trusts in the sector greater flexibility in capital allocation decisions. 

According to the Jefferies report Listed Private Equity - Exit Activity Green Shoot, there are various "'green shoots'" that could signal a recovery in private equity exit activity.

Analysts Matthew Hose and Fiona Huang noted the exit value of US private equity deals has increased quarter-on-quarter for the first time in twelve months, while HarbourVest Global Private Equity (HVPE) and Pantheon International (PIN) have disclosed growth in their Q2 distributions.

There were also signs of IPO activity, with press reports pointing to potential exit activity of some of the underlying holdings of listed private equity trusts. One example is the Spanish firm Idealista — owned by Oakley Capital Investments and Apax Global Alpha.

Investec reiterates 'Buy' rating for Pantheon International on £200m share buyback launch

To determine when these new offerings would materialise into exits, the analysts pointed to a study published by Neuberger Berman in December 2022, which analysed distribution patterns following the bursting of the dotcom bubble and during the great financial crisis.

It found that although distributions in both periods fell off immediately, the ensuing recovery in exits lagged the recovery in public equities markets before staging a complete comeback. 

If Q3 2022 was the equity market bottom, historical trends would indicate that exit activity will increase over the next few quarters, the analysts noted, with the only impediment to this being the current stand-off between buyers and sellers over valuations.

"Despite this, we believe any further (and broader) recovery in equity markets could help buyers gain more confidence, and against this, sellers may need to compromise to return capital back to LPs in order to support fundraising efforts," they said. 

Greater capital allocation flexibility 

A significant uptick in exits would provide private equity investment trusts more freedom to decide how to allocate their capital, introducing greater scope for buybacks or future commitments.

Jefferies said that although there is "clear shareholder impetus" towards making share buybacks, the firm said funds are "understandably cognisant" of their investment commitments and the longer-term opportunity cost of returning capital versus reinvestment.

"Within this sub-sector we principally see share buybacks as a 'release valve' to manage excess portfolio liquidity, but one that, if used, is likely to amplify the near-term positive impact on the share price of seeing more exits," they said. 

In a research note on 4 August, Investec condemned the listed private equity sector's dismissive stance to addressing widening discounts, noting that the listed private equity sector has "historically been quick to dismiss share buybacks, alleging they do not work".

Public/private valuation disconnect looks overdone

Pantheon International recently introduced a revision to its capital allocation policy to dedicate a proportion of its net positive cash flow to buybacks and earmarking £200m for share buybacks.

Investec said the £200m figure is greater than total listed private equity sector buybacks over the past five years. The firm also said that over the past year, estimated total buybacks by the entire sector sat at just £79m, or 0.7% of the market cap of the sector. 

While exits are "clearly beneficial" in terms of validating portfolio marks, and releasing capital to fund future commitments or distribute to shareholders, Jefferies said portfolios with midmarket exposure may be better positioned to benefit from potential exit activity.

Jefferies found almost all funds are in the four-to-five-year maturity 'sweet spot', with only  HgCapital Trust having an average maturity of closer to three-years.

"While HVPE and PIN are the most mature, this needs to be set against the fact they contain some exposure to venture and growth investments where the exit environment remains highly challenging," the analysts added.