There is increasing interest in unquoted markets as companies stay private for longer

Numerous investment trusts in recent years have asked shareholders permission to increase their exposure to companies which do not trade on a stock market, known as unquoted or unlisted.

Primarily, this is because companies are staying private for longer and this change in investment policy allows investment trusts to capture more of  the rapid growth and value generated during the earlier stage of a company’s development.

Fourteen investment trusts now have more than 10% of their assets invested in private companies, excluding trusts which have a pure private equity focus. This is according to data from the Association of Investment Companies taken at the start of 2022.

RIT Capital Partners (RCP) and Edinburgh Worldwide Investment Trust (EWI) are among the trusts that invest both in companies on the stock market (known as quoted) and unquoted ones.

Edinburgh Worldwide Investment Trust recently gained approval to increase the limit on investment in private companies from 15% to 25% of total assets at initial investment.

Pacific Horizon Investment Trust (PHI) and Fidelity Special Situations (FCSS) have also obtained the green light from shareholders to be able to invest up to 15% of assets in private markets, previously 10%.

Perhaps the best-known investment trust to blend both quoted and unquoted investments is Scottish Mortgage (SMT) which has backed numerous well-known companies before they came to the stock market including Chinese internet group Alibaba and music streaming platform Spotify.

INVESTMENT TRUST BENEFIT

Investment trusts have greater freedom to invest in illiquid unquoted investments, as they do not have to sell the underlying holdings when investors want their money back. This is in marked contrast to open ended investment vehicles.

The flexibility of an investment trust structure provides an excellent vehicle for investors to gain exposure to sectors that are impossible to access directly or inappropriate with open-ended funds.

Indeed, Luke Ward, deputy manager at Edinburgh Worldwide Investment Trust, has highlighted certain sectors of the market that remain predominantly private including the space and quantum computing sectors.

THE INFORMATION ADVANTAGE

In a recent AJ Bell Youinvest webinar, Douglas Brodie, investment manager at Edinburgh Worldwide Investment Trust, emphasised the information advantage associated with investing in both private and public equity markets.

‘For somebody who transcends both public and private markets, covering both means you are fundamentally a more informed investor. There is a danger if you only cover the listed market, you can be blindsided very aggressively by what is going on in the private sphere, with companies innovating, doing different things,’ he remarked.

EDINBURGH WORLDWIDE INVESTMENT TRUST

Edinburgh Worldwide Investment Trust aims to generate capital growth from a portfolio of initially immature problem-solving businesses, offering long-term growth potential.

Although the trust invests predominantly in listed equities, it has a remit to invest up to 25% in private companies.

Brodie believes that ‘the desire to find these high growth businesses runs deep in everything that we do, and if you think about this at its core, this extends very neatly into going down the market cap scale into earlier, younger and smaller businesses’.

The manager seeks to identify companies that can provide solutions to genuine problems in the world, as well as potentially creating new markets. In addition, he looks for management teams with a clear strategy for growth. He is attracted to business models with inherent scalability and an emerging competitive advantage.

At the end of October 2021, the trust had 11% of total assets invested in 12 unlisted companies. This represents an increase from 6% a year earlier, with six new private investments added to the portfolio.

The trust’s largest unquoted holding is Space Exploration Technologies, which designs, manufactures and launches rockets and spacecraft. It is perhaps best known because of its illustrious CEO, Elon Musk. The holding represents 4% of the trust’s total assets as of 28 February 2022.

Another key private holding is PSI Quantum, a developer of commercial quantum computing – something which promises to be a key transformative technology, with applications spanning energy, healthcare and technology.

Oxford Nanopore (ONT) and QuantumScape are examples of successful early stage private equity investments made by the trust which have subsequently listed on the public equity markets.

The former listed on the London market in September 2021. According to Numis, Oxford Nanopore has developed the cheapest and most scalable DNA sequencing technology allowing the real time analytics of genes, the building blocks of life.

QuantumScape listed on the American market in June 2020. It focuses on the development of solid-state lithium batteries for use in electric vehicles. The company claims these batteries will charge faster, go further, last longer and operate more safely than today’s electric vehicles.

Edinburgh Worldwide has outperformed the S&P Global Small Cap index over the last five years (97% versus 50% total return respectively). But performance has lagged on a one and three-year basis.

RIT CAPITAL PARTNERS

RIT Capital Partners (RCP) has the objective of long-term capital growth while preserving shareholders’ money through market cycles.

It invests in a diversified international portfolio across a range of asset classes, both unquoted and quoted. These include credit, macro strategies and real assets.

It aims to deliver long-term capital growth through the purchase of risk assets including equities and private companies, both directly and through funds.

Recent results announced at the beginning of March highlighted the trust’s ability to outperform its benchmark, and the significant contribution made by its private investments.

For the year to December 2021, the trust delivered a net asset value return of 23.6%. This exceeded the 20% delivered by the MSCI All Country World Index, as well as the fund’s absolute return target of RPI plus 3% which measured 10.5%.

PRIVATE INVESTMENTS

The key driver of performance over the year was the private investments portfolio contribution (+22.4%) evenly split between fund and direct investments.

The stock market listing of e-commerce company Coupang, often referred to as the ‘Amazon of South Korea’, proved particularly helpful to RIT’s performance.

The allocation to private investments grew significantly to 36.5% from 25.6% at the start of the year due to strong performance; 24.8% is invested in third-party funds, and 11.7% in direct holdings.

Since its inception in 1998, the trust has delivered an attractive return profile, participating in 74% of market upside, but only 38% of market declines.

Net asset value total return has compounded at 11.3% per year. This is significantly ahead of the global equities market; the MSCI All Countries World and FTSE All Share indices delivered annualised sterling returns of 7.8% and 7.1% respectively.

THE MANAGERS’ OUTLOOK

RIT executive committee members Ron Tabbouche and Francesco Goedhius anticipate short-term volatility, particularly in high-growth sectors due to shifting monetary policy and elevated valuations in certain areas. However, they do not expect a sustained equity market downturn.

Over the near term, they expect value to outperform. Reflecting this, the portfolio is defensively positioned with equity exposure of just 35%, which is at the low end of its historic range. Moreover, they have put in place hedges in expensive software stocks.

The managers highlight that ‘Whatever the underlying cause, volatility can be uncomfortable, but the flip side is that if markets react indiscriminately, this can also provide opportunities.’

Recently the managers have been increasing exposure to European value and commodity sensitive positions.

Numis maintains the trust has an exceptional long term track record through an unconstrained investment approach seeking to deliver long term capital growth, while preserving shareholder capital. The latter is becoming increasingly important in volatile markets.

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