- Trusts with a penchant for holding unlisted companies face challenges in the current environment
- We look at the issues facing some of the trusts, and possible silver linings
Investment trusts typically demonstrate their strength in a crisis. Closed-ended equity income funds shrugged off the dividend cuts of 2020 thanks to revenue reserves, while trusts' investment framework means they have encountered none of the liquidity problems demonstrated so clearly by the Neil Woodford scandal.
That structure, well suited to hold illiquid investments, has helped investment trusts capitalise on growing demand for alternative assets, of which unlisted companies have formed a part. From an increased focus on private companies within Scottish Mortgage (SMT) and other Baillie Gifford vehicles to the rise of “growth capital” portfolios such as Chrysalis (CHRYS), trusts with exposure to unlisted businesses have proved popular. But a turn in market conditions reminds us that closed-ended portfolios with private holdings can still encounter challenges of their own.
The pain in the price
Chrysalis shareholders are nursing a paper loss of 76.4 per cent for the 12 months to 4 November, with the shares recently trading at an eye-watering 65.8 per cent discount to net asset value (NAV). The NAV itself fell by 22.8 per cent in the second quarter of this year alone partly due to Klarna, which represented nearly a fifth of the portfolio at the time, having been written down by some 78 per cent. That was in line with a recent fundraising round for the buy now pay later business in which investors were unwilling to back the business at its previous valuation. Elsewhere, Scottish Mortgage applied a swathe of writedowns to its unlisted holdings in the first half of 2022.
A focus on unlisted companies with exciting secular growth stories leaves such portfolios exposed to the style rotation of the last year, in which growth has been de-prioritised in favour of reliable earnings streams. Those investors may also have bought into such businesses at frothy valuations – note Klarna’s tumble to earth or the 61.8 per cent fall for Schroder UK Public Private (SUPP) top holding Oxford Nanopore (ONT) in the first half of 2022 following a highly anticipated 2021 flotation. Even these steep losses do not automatically mean the trusts' positions are underwater – given such investments were originally made several funding rounds earlier – but that will be of cold comfort to those now seeing their holdings go into reverse.
Trusts like these now tend to trade at big share price discounts to NAV, and one argument runs that the portfolio holdings have also reset to more compelling valuations. Oddly, another silver lining could be that some especially concentrated portfolios have actually become more balanced: Oxford Nanopore went from making up 36.9 per cent of the Schroders portfolio at the end of 2021 to a slightly less chunky 21.3 per cent halfway through this year. But things are less simple for Chrysalis, where Klarna represented just 6.1 per cent of the portfolio on 18 August, but Starling Bank made up 20.1 per cent and wefox accounted for 17.1 per cent.
Surviving the storm
From Oxford Nanopore’s gene sequencing specialism to the attempts of wefox to disrupt the insurance industry, investors may still like the premise of such companies – and accept that some fail while a few become huge successes. But they will also be asking whether fledgling businesses can survive long enough to ultimately prosper, especially in today's economy.
A trust’s ability to meet cash demands from its holdings could be crucial here, and in interim results published at the end of June the Chrysalis investment team stressed the need to “reserve sufficient capital to support the existing portfolio while this market dislocation remains” rather than, for example, conducting buybacks.
Portfolio restrictions may cause problems for some. Scottish Mortgage, for one, currently adheres to a 30 per cent limit on exposure to private companies at the time of purchase. QuotedData's James Carthew points out that this exposure came to 31.8 per cent at the end of September – meaning the team could struggle to provide those private holdings with extra cash for now. The fact that listed shares' valuations change daily, in contrast to unlisted companies' much more sporadic valuation updates, can lead to the latter becoming more prominent in portfolios when markets suffer and listed shares fall – if a portfolio holds a mix of both assets.
Other dividing lines may also prove important. Some will argue that more mature unlisted companies, such as businesses that are close to IPO, should be more stable. But earlier-stage names may in fact appear less volatile themselves due to valuation methodologies. Mick Gilligan, head of managed portfolio services at Killik & Co, says: “Early-stage investments tend to be valued at cost (ie, based on the last funding round), whereas mature investments tend to be valued by reference to quoted peers. On this basis, portfolios that are skewed towards more mature businesses are (on balance) likely to see bigger writedowns.”
Gilligan points to Seraphim Space (SSIT) as one example of an early-stage portfolio that potentially demonstrates greater resilience. It recently reported a small NAV increase from its IPO in the summer of 2021 to the halfway point of this year, with the top 10 unquoted holdings in the portfolio reporting growth in both revenue and bookings. Two early-stage investments were written down to nil, but this only cost the portfolio around 1 per cent in performance terms. Investors are not particularly convinced, however: the trust's share price has still fallen 63 per cent this year.
Find below all the features in our special issue celebrating the investment trust.
Spotting the true discount bargains - Val Cipriani highlights investment trusts trading at a discount
Where the money has been flowing in a year of turmoil - Dave Baxter looks at how investment trusts have fared in raising funds this year
IC Income Portfolios - one year on - Dave Baxter reveals how our experts' pick of income trusts has performed and what changes are being made
Around the world in eight investment trusts - Alex Newman runs our global investment trust stock screen to produce the best investment ideas for regional diversification
Gearing up and down - Val Cipriani reports on the big gearing movements in the investment trust world over the past year
The professional picks 2022 - Our panel of experts pick their preferred investment trusts for the year ahead
Investment trusts hold up as refinancing risk looms - The sector has largely timed refinancing right
Capital preservation with a personal touch - Personal Assets Trust provides an asset allocation case study for a tough bear market
How cheap is Scottish Mortgage? - Looking beyond the growth trust's price tag
Investment trusts' unlisted headache - Exposures to private companies have brought their share of problems
When discounts signal a new buying opportunity - Our investment trusts system bottomed early in 2009, will history repeat?
