Are unlisted investments better?
Recently we’ve been reviewing several unlisted investment funds that invest in assets such as unlisted property or infrastructure, as well as some private debt and private equity exposures. These sorts of investments have become very popular with institutional investors in recent years, who argue that unlisted assets offer superior returns and lower risk than their listed equivalents, and these benefits more than compensate for the additional fees.
It seems plausible that unlisted investments offer the potential for higher returns: with fewer potential investors and more difficulty in transacting, they could trade more cheaply than listed peers. But recently we’ve seen several takeovers offers for listed investments to take them private, and these offers have been at substantial premiums to the investments’ share prices. That suggests that the assets’ new owners will receive lower returns in future than the equity holders would have.
On the risk side comparisons are more difficult, because unlisted assets are valued by accounts determining what the fair value of an asset should be using a model, while the market valuation is a real time indicator of what another investor would pay for the asset right now.
Listed and unlisted investment comparison
Below is a comparison of the evolution in value of two equivalent property portfolios, both indexed to start at 1 ten years ago.
On the face of it, the unlisted portfolio would seem far less risky with much more stable returns. And when we calculate the risk and return statistics we can see that the Sharpe ratio (the reward to risk) and the drawdowns for the unlisted assets are vastly superior to the listed assets – nearly triple the reward to risk over the long term and less than one tenth the drawdown during the COVID crisis.
|Returns and risk|
You can probably tell that there’s a twist to this story: in this case, our sample portfolios are exactly the same assets. We’ve compared the growth in the accounting valuation of an equally weighted portfolio of REITS to the growth in their market valuations. (We chose REITS because the assets in a REIT are regularly revalued using more objective criteria than ordinary stocks.)
This is a stark example of why it’s unwise to try to compare the performance of listed investments that are marked to market with unlisted investments that are marked to models. The market valuation and the model valuation are measuring quite different things.
One could argue that this comparison is unfair to unlisted assets, because actual funds are revalued in a more market sensitive way than REITs. While there’s some truth in that, the unlisted funds that we’ve looked at and some private asset whose valuations we’ve reviewed were generally marked down by around 10% during the COVID crisis, while very similar listed investments fell by more than 30%. In most cases the unlisted funds needed to make special adjustments to their valuation to get the valuations to fall even 10%.
That’s not to say model valuations are wrong. In many ways we would say that the listed markets overreact to these events, and the unlisted style of valuation is a better indicator of long term value (albeit one that is very reliant on your assumptions). However, with their long application and redemption windows, you often cannot transact in unlisted investments at the time that the differential is highest. When you’re looking to rebalance your portfolio to reduce risks or take advantage of buying opportunities in the middle of a crisis a theoretical price that you can’t invest at is not much use.
So for now we remain focussed on listed investments with clear market pricing, even if that makes the apparent volatility of our portfolios higher.
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This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.
Please note that past performance is not a reliable indicator of future performance.
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