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Unquoted uncertainty?

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15 May 2020

David Prosser explains how it can pay to update valuations of unlisted holdings during times of market turmoil.

It’s an odd thing to see an investment company announcing a fall in the value of its assets and enjoying a share price bounce as a consequence. But this is what has just happened at Scottish Mortgage; after unveiling a write-down of its unquoted investments amid the market volatility caused by the Covid-19 pandemic, its share price rose 2% - and that on a day when the market as a whole was down.

Analysts said Scottish Mortgage’s early intervention removed some of the uncertainties surrounding its portfolio of unquoted stocks. When listed shares fall markedly, as they have done during the pandemic, investors naturally become anxious about unquoted stocks, for which previous valuations can very quickly look out of date. It’s therefore important for managers to update these valuations as soon as possible; otherwise they risk speculation that more damage has been done than is actually the case.

In Scottish Mortgage’s case, unquoted investments only account for about 20% of the fund, which will also have mitigated the impact of the write-downs. But what of those funds that invest solely in unlisted equities in the private equity sector of the investment company universe?

Well, much of the sector has suffered a sharp downturn in valuations amid the market disruption. Shares in the majority of private equity funds currently trade at discounts to the value of their underlying assets of more than 25%. Partly, that’s a reflection of the general market sell-off, but the additional problem is that investors aren’t confident about what the value of those underlying assets really is.

To their credit, several funds have sought to move quickly, just like Scottish Mortgage. Both Pantheon and Princess Private Equity updated valuations at the end of March; other funds in the sector are still applying end-December valuations to their unlisted holdings, but will revalue over the weeks and months ahead.

Significantly, both Princess and Pantheon are trading on narrower discounts than most of their peers, reflecting at least in part the greater visibility they have been able to offer investors. And herein lies a question – do the steeper discounts of funds yet to revalue their holdings suggest that investors are under-estimating what their portfolios are worth? Could investors be in for a pleasant surprise once they get an update? That appears to have been the experience of Scottish Mortgage, Princess and Pantheon.

There are no guarantees, but more broadly it was interesting to see an upbeat note on the private equity sector from the investment companies team at Numis in recent days. Its analysts believe ratings in the sector now represent “a compelling buying opportunity and a good starting point for attractive long-term returns”.

Their argument is that investors are under-rating the sector, which is much less geared than in the run-up to the global financial crisis and much less exposed than listed equity funds to the most cyclical sectors of the economy, which are at greatest risk during a Covid-19 downturn. Many funds are focused on defensive sectors such as healthcare, technology and consumer staples, Numis points out.

That’s food for thought for investors wondering where to look for bargains amid the current stock market turmoil. And it’s worth remembering that for investors interested in unquoted stocks, investment companies offer an accessible and affordable route into the sector. Private equity used to be the preserve of high-net-worth investors and institutions, happy to make six- or seven-figure minimum investments and lock up their capital for years; investment companies, by contrast, enable everyone to participate through a liquid vehicle that can even be held within an individual savings account (Isa).