Earlier this month Caledonia Investments (CLDN) acquired a 98.9 per cent stake in Deep Sea Electronics, which produces controllers for diesel-powered electricity generators and battery chargers. Another key feature of this company, for which Caledonia is paying £117.2m plus a £50m bridging loan, is that it is not listed on a stock market.
This is not the trust’s only unquoted investment – Caledonia has been investing in these since 2011 and now has an allocation to them of around 35 per cent, in line with its aim of investing between 35 per cent and 45 per cent of its assets in unquoted investments.
But Caledonia is not ranked in the Private Equity investment trust sector or even in the Flexible Investment sector, which includes a number of multi-asset funds. Rather it is a Global trust alongside funds that purely focus on listed equities. And there are a number of other trusts ranked in mainstream investment trust sectors that have an allocation to unquoted assets, notable examples including Woodford Patient Capital Trust (WPCT) in the UK All Companies sector, Scottish Mortgage Investment Trust (SMT) and Foreign & Colonial Investment Trust (FRCL) in the Global sector, and Fidelity China Special Situations (FCSS) in Country Specialists: Asia Pacific.
Other trusts, meanwhile, such as Lindsell Train Investment Trust (LTI) and Chelverton Growth Trust (CGW), invest in the unquoted management companies that run them.
It is important to know which trusts have an allocation to unquoted investments as there are some big differences between their risk/return profile and that of quoted investments, as well as of the trusts that hold them.
Having the ability to invest in unquoted investments can be beneficial. It means a trust has a wider opportunity set than a peer that just invests in listed investments – and to access the best opportunities in some areas, for example biotechnology and technology, it may be necessary to look beyond public equity markets.
A trust with an allocation to unquoted investments is potentially more diversified from a risk/return perspective. In falling markets, for example, its net asset value (NAV) might fall less than that of a peer purely focused on listed investments and generally be less volatile, and this could be reflected in its share price.
And if a trust has a large holding in an unquoted company it may have more influence in its running than with listed holdings, of which it probably holds a smaller percentage.
But unquoted investments mean the valuation of a trust’s assets is not as transparent. If a trust only invests in quoted investments its NAV can be calculated every day by looking at what their share price is. But unquoted investments are only typically valued between two and four times a year, so if there is a change in their value this might not be reflected in the trust’s NAV figure for months.
“Be careful when looking at the discount or premium to NAV of a trust with exposure to unquoteds because assets may not have been revalued up [or down],” says David Liddell, chief executive of online investment service IpsoFacto Investor. “Typically private equity trusts trade at a discount to NAV because of doubts about their valuations. It also reflects their risk – you can’t get out of these investments as easily, and performance is likely to diverge more from the benchmark than with trusts only invested in listed equities.”
For example, Caledonia was trading at a discount to NAV of 20.4 per cent (at close on 23 October) – the widest in the Global sector. This is partly because one shareholder, the Cayzer family, holds 48.5 per cent of the shares, constraining the volume of share buybacks that can be done. But analysts at broker Numis Securities add: “In part, [the relatively wide discount also] reflects the fund’s exposure to unquoted assets. The NAV lagged in recent years during the period of rising equity markets, although a high weighting in the UK relative to peers has also been unfavourable. However, the NAV has been more resilient in the recent weak market and we continue to believe that Caledonia offers significant value for long-term investors.”
Woodford Patient Capital Trust, meanwhile, was trading at a discount to NAV of 15.3 per cent at close on 23 October. This may be because its share price is not reflecting a recent revaluation of its investment in Industrial Heat, the value of which was increased 357 per cent to $112.9m (£87.3m), resulting in a NAV rise of 8.02p a share. And this NAV increase was not reflected in the NAV until 21 September, although presumably Industrial Heat was worth that amount before this exact date.
How the risk and profile of a trust with an allocation to unquoted investments compares with sector peers purely focused on equities depends on how large its allocation to unquoteds is. If this is more than 10 per cent, it could have a meaningful effect on its overall returns. How the trust gets exposure to the unquoted assets is also important. Are they direct holdings or accessed via pooled funds, which should give exposure to a greater number of holdings, diluting the risk of each one? And if it is via direct holdings, how is the exposure dispersed – is it small allocations to several unquoted investments or large bets on maybe just one or a few investments, increasing concentration risk?
Because of these risks, if you invest in a trust with a substantial exposure to unquoted investments, of say more than 15 per cent, Jason Hollands, managing director at Tilney Investment Management Services, suggests that you already have a diversified portfolio of listed companies. Also look to see if the trust's management team has the right skills and capabilities, as investing in unquoteds involves different considerations and more research than investing in mainstream listed investments.
And don’t assume that any investment trust just holds equities, even if its name and sector categorisation don't indicate exposure to other assets. Always look carefully at an investment trust's holdings and investment strategy before you commit money to it.
