Why access private companies through investment trusts?

Unquoted companies offer the exciting potential for unbridled growth, albeit with a high level of stock-specific risk. With companies taking longer to reach IPO stage, there are more opportunities in this space, and now even mainstream investment trusts are making unlisted businesses a significant part of their portfolios.

Unlisted for longer

Last year, private equity activity in the UK market reached levels not seen since before the global financial crisis, with deals worth £45.8 billion, according to the Centre for Private Equity and MBO Research.

Thanks to technology, companies are increasingly able to scale up without having to come to public markets to raise money. By staying unlisted for longer, they can retain more control of their business as they grow.

“There was a time when any company of size and ambition would opt for a market listing as soon as it could, for both the capital and prestige,” explains investment trust expert Andrew McHattie. “That has changed now, and companies are staying private for longer, tapping into new sources of capital outside of the public markets and enjoying more freedom away from the media glare and the need to show progress in each quarterly set of figures.

“For investors, this means there are more high-quality opportunities than ever amongst unquoted companies that remain private because they choose to, rather than because they are too small or failing to meet corporate governance standards.”  

Because companies are coming to market later, waiting until IPO to invest could mean missing out. “The real growth is happening while these companies are private,” says James Carthew, head of investment companies at QuotedData. “They only come to market when everyone’s made their money and wants to cash out.”

While there is huge growth potential if you back a future winner, the risk is also much greater in early-stage businesses, and portfolio managers need a different skill set to choose correctly in this sector.

“It’s a different sort of risk, so shareholders have to be comfortable with the fact that, when markets are racing, you might get left behind for a while because valuations in private equity happen infrequently and they’re still quite cautious,” Carthew adds.  

How to access unlisted companies

Investment trusts offer the perfect gateway to access private companies and benefit from their growth before they reach IPO stage, simply because the closed-ended structure means they have the flexibility to hold illiquid investments such as these.   

But investors don’t have to buy a private equity investment trust to dabble in unquoted companies – increasingly, they are forming part of more generalist trusts’ portfolios. Baillie Gifford, for example, has numerous trusts with private company exposure – Scottish Mortgage trust has 21% of its portfolio in 49 private companies, while Edinburgh Worldwide is also planning to increase the percentage of its portfolio in unlisted companies to 25%. Self-managed trust Caledonia investments has also performed well with a mix of private and public investments.

For a more specialist option, there’s the Growth Capital sector which invests in later stage venture capital.  Whereas the Private Equity sector takes larger controlling stakes of private companies. Standard Life Private Equity, Pantheon and HarbourVest are funds of funds which invest in a broad spread of private equity investments, while Oakley and HgCapital are among those investing directly in a smaller group of companies; the former group should offer you a “smoother ride”, explains Carthew.

However, with that comes greater cost in the form of a performance fee-type charging structure. But, for him, these trusts are worth the money. “Some people say they wouldn’t touch private equity because the fees are too high, but are you really willing to walk away from those returns for the sake of that argument? I would say no.”