Unlisted value

The best companies aren’t always to be found on the stock market. Elon Musk has run into trouble for suggesting he might take Tesla back into private hands and Mike Ashley’s occasional suggestions he might do the same with Sports Direct have often accompanied the latest controversy at the sports retailer. But these examples illustrate an important point: successful businesses do not have to list their shares on a public exchange.

In fact, there appears to be a trend away from doing so. Worldwide, there are now more than 250 so-called unicorn businesses with a value of more than $1bn that remain privately owned. They include many fast-growing technology businesses launched over the past five to 10 years, which have little trouble picking up funding from private equity funds and venture capitalists.

All of which begs a question. Are investors missing out on some of the most attractive opportunities because stock in these businesses is not easily available? Indeed, buying into publicly-listed companies has its downsides: you’re typically investing in the company during a more mature period in its lifecycle; that may be less risky, but it may also mean you have missed out on the fast rates of growth offered in its early years.

The good news is that the investment companies sector now offers two means with which to remedy this situation.

First, there are 25 or so listed private equity funds offering exposure to a portfolio of the manager’s privately-owned businesses. These closed-ended funds offer a route into an industry that has traditionally been the preserve of high-net-worth individuals and institutional investors. They make strategic investments in businesses they judge offer the potential for high growth over the next three to five years, often taking controlling stakes to maximise their influence over the direction of the company.

The second closed-ended fund option for exposure to investment in private companies is a fund such as Scottish Mortgage Investment Trust or Woodford Patient Capital. These vehicles have a mandate to invest – to a greater or lesser extent – in private companies alongside their portfolios of listed equities. The hope is that the former will provide a turbo boost to the performance of the latter.

The second approach isn’t a pure play on privately-owned businesses and managers often taken minority stakes in companies rather than owning a majority. Interestingly, in a recent article for Investment Week, the analyst William Heathcoat Amory, of Kepler Trust Intelligence, described this approach as riskier, on the grounds that the manager has less control over the running of the business or when it is sold. You might also argue, however, that buying stakes in privately-owned businesses alongside publicly-traded shares represents a way to mitigate risk through diversification.

Inevitably, some investors will be attracted to private equity funds while others will prefer a less specialist vehicle. But either way, it’s worth making the point that the structure of investment companies provides a means to take a stake in these businesses that would be difficult with any other type of collective fund.

In an open-ended fund, where purchases and redemptions mean that the size of the fund ebbs and flows, sometimes dramatically, managers struggle to invest in illiquid assets such as private companies. The danger is that they are forced to try to sell at a time not of their choosing, often with unfortunate consequences. Closed-ended funds, by contrast, do not face this issue.