Unquoted shares, or private equity, are sometimes perceived as riskier than their listed counterparts, as they tend to be more difficult to sell and have looser requirements for disclosure.
However, a number of high-profile investment trusts have recently turned their attention to the space, with the intention of taking advantage of opportunities in private markets.
The board of Fidelity’s £759m China Special Situations trust proposed to double the trust’s limit on unlisted stocks to 10 per cent recently, citing Chinese companies’ increasing tendency to turn to private markets when fundraising as a reason behind the move.
Earlier in the year, the £3.4bn Scottish Mortgage Trust made a similar proposal, seeking to formalise a cap on unlisted and private equity holdings at 25 per cent of the fund, compared with a current informal limit of 15 per cent.
Both vehicles have invested in Chinese company Alibaba, known for being the largest ever US-listed initial public offering, from an early stage before it entered the public market.
Meanwhile, other high-profile figures have made the case for such investments. At the end of April, Neil Woodford, head of investment at Woodford Investment Management, had 43.2 per cent of his £803m Patient Capital Trust allocated to unquoted shares.
“The more that we have done in this space, the more we have become convinced this is an incredible area for investment. The early-stage asset class is largely neglected and fundamentally undervalued,” Mr Woodford explained.
This uptake of investment in unquoted holdings reflects the difficulty growth managers have in accessing disruptive companies solely through public markets, according to Innes Urquhart, part of the research team at Winterflood.
“This is particularly the case where companies are operating in relatively less capital-intensive industries and are therefore not reliant on being able to access public markets to fund growth plans,” Mr Urquhart says.
However, he notes that investing in unquoted holdings could bring new factors – such as liquidity risks – into play.
“Investment in unquoted holdings does alter a fund’s risk profile, and, given that [they] tend to be revalued only on a quarterly or semi-annual basis, it is also likely to impact on a fund’s reported performance,” he says.
“That is not to say that [they] are in themselves higher risk and, to take Scottish Mortgage as an example, its unquoted holdings are already substantial businesses.
“That said, where an investment underperforms or the investment case changes, it is likely to be more difficult to reduce exposure.”
Other specialists warn that transparency issues could arise.
Charles Murphy, investment funds analyst at Panmure Gordon, says that while he does not expect an issue in the short term, the use of unquoted equities could make it difficult to properly value portfolios in the long term.
“My concerns relate to the fact that once unlisted companies represent a significant proportion of the portfolio, investors will start wanting to know more about them,” he explains.
“Given that the managers have normally signed non-disclosure agreements and won’t discuss the companies or how they value them except in the most general terms, I believe that these issues may generate a degree of cognitive dissonance – especially if recent investment performance has been dull or other managers have publicly reported writing down the value of their investments but the trust in question hasn’t.”
Mr Murphy also notes that a number of the funds using unlisted holdings operate with zero-discount policies, which he believes is ultimately incompatible with investing a meaningful proportion of a portfolio in them.
The analyst believes the popularity of unlisted holdings could be growing because the listed equity markets no longer function as a reliable source of expansion capital for growth companies compared to the private markets – with these currently acting as a source of exit liquidity for investors once companies have matured or passed their fastest phase of growth.
And, while he acknowledges the claim unlisted assets could help to differentiate trusts from their open-ended peers, Mr Murphy is unconvinced this is the only rationale behind such a shift.
“I am uncomfortable with listed managers buying unlisted companies, although I do recognise it as a source of differentiation. But I don’t think it’s driven by the need to differentiate – the tail isn’t wagging the dog,” he says.
