Page 49 - DIY Investor Magazine | Issue 32

Historically, companies found stock markets an important source of equity capital they needed to grow. Increasingly, private capital has allowed companies to grow to a global scale without listing on a stock exchange. Scottish Mortgage is a high profile trust whose managers embraced this and contributed very strong returns for shareholders.
Governments around the world increasingly accept market- led approaches to fund essential infrastructure and renewable energy; with a commensurate increase in funds being in a position to offer capital in these areas.
Finally, the GFC led to increased regulation in banks, and higher capital requirements limited their ability to lend. This offered an opportunity for non-bank lending which, given the fall in interest rates, saw a huge rise in interest from investors attracted to the income and lower risk investment characteristics.
‘INVESTMENT TRUSTS PROVIDE AN EXCELLENT STRUCTURE TO HOLD LONG TERM, ILLIQUID ASSETS’
WHY MIGHT PRIVATE ASSETS MAKE BETTER INVESTMENTS?
For long term investors of all types, private assets make sense in a portfolio. ‘Diversification, the only free lunch in investing’
is widely attributed to the Nobel Prize winner Harry Markowitz, on whose work much institutional investing theory is based. Listed investments are arguably just an accident of history,
so investors should examine the diversifying potential of other private assets.
There is a wide opportunity set, and the complexity and illiquidity involved in buying, managing and selling assets
give good managers the potential to add significant value in less efficient markets. The opacity and expertise required to manage these assets means investment risks are potentially higher, but scale is also important, as many private assets have a ‘unit size’ of many millions of pounds, euros or dollars.
So how do non-institutional investors access these assets? In our view nothing can beat an investment trust, which provides an excellent structure to hold long term, illiquid assets.
In many areas, trusts already offer access to ready-made portfolios of private assets, which might otherwise take
an institution (eg Calpers or Yale) months or even years to assemble – at significant cost.
As well as being able to ‘try before you buy’ – in analytical terms - investment trusts provide daily liquidity (admittedly of varying degrees) where otherwise there is none, at negligible cost and sometimes a material discount to NAV.
Buying at discounts/premiums to NAV adds risk and opportunity, but for most investors without a multi-decade investment horizon, liquidity is a significant advantage that outweighs the disadvantage of a discount potentially widening significantly.
An expert, independent board ensures the manager is performing their role correctly, reassuring non-experts in any asset class that their best interests will be looked after.
PRIVATE EQUITY
Private equity is investing in unlisted companies, arguably the most established ‘private’ asset class; we define three types of private equity investing:
• Buyouts – managers typically buy a controlling interest in a mature or semi-mature company, aiming to significantly grow its revenues and profits, often using significant debt financing, seeking a sale after three to five years. AIC Sector: Private Equity.
• Venture Capital – managers invest in early-stage companies, with explosive growth potential. They typically contribute to the founder’s growth strategy as well as capital markets expertise in terms of achieving an IPO
in the future. There is no specific AIC Sector, but VC is included in some funds in the AIC Private Equity peer group.
• Growth capital – managers invest in pre-IPO opportunities, expecting the company will sell in the short to medium term. The strategy for each company will typically have been set, so investment is less about the input of the manager, and more about capital. AIC Sector: Growth Capital.
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DIY Investor Magazine · Feb 2022