Investor interest in early-stage private companies will build as new crowd-sourced equity funding (CSEF) rules take effect in late September. But as more people invest directly in private companies, another option is gaining exposure though specialist Listed Investment Companies (LICs).
Investing in private companies is not for everyone. Risks are elevated because earlier-stage companies are, by their nature, speculative. They are not subject to the same level of compliance, disclosure and governance as ASX-listed companies.
Liquidity is another issue. Those who value price discovery on exchanges and the ability to buy and sell shares quickly when needed will find less joy in early-stage private companies. Their liquidity events can be sporadic and often revolve around capital raisings.
The ASX, with its long tail of micro-cap companies, has plenty of choice for speculators. Why invest into unlisted private companies when there are more than 2,000 microcaps on ASX?
The answer, of course, is potential for higher returns. The ability to invest in emerging companies at the seed-capital stage, well before they get to an Initial Public Offering is a lure. There can be a huge value uplift for successful companies that make it to a trade sale or IPO.
A less considered benefit is diversification. Private companies are typically less correlated to movements with other asset classes. A listed company might tumble when global sharemarkets correct, but that private company’s value could be less changed.
Institutional investors have long recognised that alternative investments, such as private equity and venture capital, should play a part in portfolios. Apart from the potential to boost returns, these assets offer different types of exposure, thus boosting portfolio diversification and reducing risk.
It’s harder for retail investors, such as Self-Managed Superannuation Funds, to gain exposure to alternative assets, including early-stage private companies. But that will change when the Federal Government’s new rules allow retail investors to invest up to $10,000 per company via a licensed crowd-sourced equity funding platform, from September 29.
The question is whether to invest directly in early-stage companies or through a listed or unlisted fund that invests in a basket of such companies.
It depends, of course, on one’s risk tolerance and portfolio goals: experienced investors and speculators might invest directly in early-stage private companies. Other could use LICs that own a basket of unlisted private companies.
LICs, of course, have their own risks. Smaller LICs often suffer from liquidity problems and trade at a persistent discount to their Net Tangible Assets (NTAs), frustrating shareholders and the LIC manager.
Either way, it’s likely that most investors would only allocate a small fraction of their portfolio to alternative investments. For example, 5% of a growth portfolio, 3% of a balanced portfolio and no exposure to alternatives in a conservative portfolio.
Even though exposures are small in the scheme of an overall portfolio, picking the right alternative investments can make a big difference to long-term returns.
Here are three LICs to consider:
1. Bailador Technology Investments (BTI)
Bailador listed on ASX in November 2014 through a $25-million IPO. After brief post-listing gains, it has struggled to trade above its $1 issue price and hit 86 cents this month.
The LIC invests in unlisted Australian and New Zealand technology companies that have revenue and an established customer base. Companies that, by definition, are past the start-up phase and in the growth phase as they try to engineer explosive user and revenue growth. This is a tough market for retail investors to gain diversified exposure to in a fund format.
Bailador has a high-conviction investment style: its portfolio includes stakes in nine tech companies in areas such as e-commerce, subscription-based internet businesses, online marketplaces and software-as-a-service companies.
Bailador has a strong management team for an LIC its size. Former Fairfax Media CEO David Kirk is a co-founder and partner, as is Paul Wilson, a former director of Champ Private Equity in Sydney and New York.
The LIC traded at a 20 per cent discount to its pre-tax Net Tangible Assets (NTA) in June 2017, ASX data shows. In theory, investors are buying a $1 of assets for 80 cents.
Bailador’s portfolio achieved upward revaluations in FY17, but its share price has drifted. Like many smaller LICs, share liquidity is an issue that weighs on the NTA discount.
A Bailador investment, Straker Translations, is working towards an IPO in FY18. That could be a point of significant valuation realisation for Bailador.
Source: ASX
2. Acorn Capital Investment Fund (ACQ)
This LIC is somewhat of a halfway house for investing in earlier-stage growth companies. About a quarter of the fund is invested in unlisted companies; the rest mostly in ASX-listed microcaps.
Four of Acorn’s top-10 holdings were in unlisted companies at July 2017 and the LIC has investments in 12 unlisted companies. For example, it owns 4.7% of Australian fertility technology provider Genea.
Acorn listed on ASX in May 2014 through a $50-million IPO. The LIC’s $1 issued shares hit 70 cents within two years of its listing, then rallied to $1.09 in September 2016. The shares are back at 94 cents, in line with broader weakness in small-cap LICs.
The LIC comes from Acorn Capital, a boutique micro-cap manager for almost two decades. The fund’s underlying portfolio has returned 5.77 per cent annually since inception in 2014 – just below the All Ordinaries and Small Ordinaries accumulation indices.
At the current price, Acorn trades at a 15% discount to its latest stated NTA of $1.11. A discount is warranted given the fund’s portfolio performance since listing. But the LIC has mostly traded at a narrower discount to NTA in the past.
Source: ASX
3. Blue Sky Alternatives Access Fund (BAF)
The Queensland-based manager has been one the better-performed LICs in the past two years. Blue Sky’s $1 issued shares, sluggish after its $60-million IPO in 2012, have rallied to $1.20.
Investors who bought shares in the LIC’s manager, Blue Sky Alternative Investments (BLA), have done much better. After listing at $1 a share in 2012, Blue Sky Alternative Investments has soared to $10.90 – again proving the adage that it’s often better to buy shares in the manager than shares or units in their products.
Blue Sky Alternative Investments delivered a cracking FY17 result: revenue rose 35% to $85 million and underlying net profit rose 56% to $25.5 million. Assets under management rose more than $1 billion to $3.25 billion.
The LIC, in contrast, has had less fanfare. At $1.20, Blue Sky Alternatives Access Fund trades at a slight premium to its latest stated Net Tangible Assets (NTA) of $1.15 in July. For a manager of Blue Sky’s quality in this asset class, a premium is warranted.
Only a quarter of the LIC is invested in growth companies and venture capital; the rest is in property, water funds and cash. Thus, the LIC suits investors wanting diversified exposure to alternative investments, not only emerging companies.
But the LIC is a cheaper way to gain exposure to the alternative assets theme compared to its ASX-listed parent, which looks fully valued after stellar investment performance and price gains.
Source: ASX
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at August 24, 2017.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.