The Times is a bit slow off the mark:
"These are, for some, wobbly times in the stock market. The Rothschild family lost £70 million on paper in the space of only a few hours the other day. Shares in the family’s RIT Capital Partners investment vehicle, a listed company in the FTSE 250 and a popular stock with retail investors, plunged by 10 per cent amid scepticism about the value of its underlying assets.
That won’t much faze wily old Jacob, Lord Rothschild, 86, the paterfamilias, now retired, an adventurous sort who co-founded St James’s Place Capital and once thought nothing of launching a huge hostile bid for BAT, the tobacco group. His family and its charitable trusts own 21 per cent of RIT.
But it does illustrate a wider issue facing many of Britain’s investment trusts and their investors, big and small. It also helps to explain why the overall sector is trading at an average discount to net asset value of 13 per cent — the widest since the global financial crisis of 2008, apart from a spike at the start of the pandemic.
In theory, it’s very odd that assets valued at a pound can be freely bought for 87p. Scaled up across the entire £265 billion investment trust sector, it means something like £34 billion of “free money” is going begging. No wonder some analysts are starting to put “buy” recommendations on many trusts.
First, though, back to RIT. Worries began in early December, when Investec issued a negative note warning of “a material increase in the risk profile” of the company, citing the way its holdings of private, illiquid assets had soared from 24 per cent of the portfolio to 45 per cent in two years. Investment in venture capital funds, the spiciest corner of the private equity world, had risen from 1 per cent of the portfolio to 19 per cent over seven years. Oh, and there was also 4 per cent of that pot earmarked for ventures in crypto/blockchain.
RIT, Investec said, was no longer the “classic safe harbour” it purported to be. Some of those concerns were echoed in a column in The Telegraph last week, which led to that share price dive. About 1.8 million shares changed hands on Thursday and Friday, five times the normal daily average. At one point, the shares were trading at a 19 per cent discount to the latest net asset value figure. The big guns were brought out in defence of RIT. Numis, the company’s broker, called the sell-off “unwarranted” and a “standout opportunity” to buy. Peel Hunt said the reaction was overdone, pointing out that four out of five of RIT’s biggest unlisted investments were already profitable and therefore less vulnerable to writedowns suffered by earlier-stage, blue-sky punts.
Even so, RIT is not seen as quite the same organisation as it was ten years ago, when it was billed as the classic pessimists’ investment vehicle, just as interested in preserving capital in the bad times as growing it in the good. Back then, it had plenty of ballast in the form of gold and lower-risk securities such as bonds, as well as greater exposure to listed companies, where valuations were based on freely traded shares and were indisputable.
While an independent investment committee has the final say on valuations, the fact remains that the unlisted holdings are initially valued by the trusts’ own fund managers. There’s no independent valuer. Likewise, its large holdings in venture capital funds inevitably partly reflect the sunny view of those who manage them.
This is not an issue confined to RIT. Dozens of conventional investment trusts have dramatically increased their holdings of unlisted stocks in recent years, arguing that this is where the most promising value lies. Scottish Mortgage, Britain’s biggest investment trust, has 29 per cent of assets in unlisted companies.
Many more investment trusts have been created to back illiquid assets, where there is no daily trading and pricing of the underlying assets to reassure investors. Property-based trusts are the classic case, but in recent years new trusts have been created to own anything from wind farms to song catalogues.
The discounts at which their shares trade relative to net assets can be as much as 50 per cent. Investors in effect are telling them: “We don’t believe you.” Yet auditors continue to sign off the accounts without blinking. The net assets line is simply a calculation based on a backward-looking formulaic system and not always what a reasonable person would describe as “true and fair”.
Two forces are driving this disparity. One is the remarkable lag between valuations in listed companies and valuations in private ones. Take unicorns, those privately owned growth companies said to be worth $1 billion or more. Valuations of American venture capital-backed unicorns that have listed already were down by 59 per cent in the first 11 months of 2022, according to Morningstar/Pitchbook index. The index of unlisted unicorns, by contrast, was up by 1 per cent over the same period. Go figure.
Alan Brierley, at Investec, believes there is going to be a valuation reset across the industry as private companies run short of cash and are forced to go back to investors for fresh capital, at much lower valuations. We saw that last year when Klarna sought fresh cash that valued it at only £6.7 billion, down from £45.6 billion 13 months earlier. Ultimately, there will be price discovery and it will be “painful”, according to Brierley.
The other factor is the dramatic rise in interest rates and government bond yields. Owners of many types of asset use a discount rate to calculate the real value today of income streams decades into the future. A tiny increase in the discount rate can have a huge negative impact on present-day valuations. Some trusts have been less keen to lift the discount rates they use in the face of this change.
Investment trusts are a good way of holding illiquid assets, far more sensible than open-ended funds, but it makes it even more important that their stated NAVs are kept up-to-date and truly reflect reality. The widening of discounts points to an industry in danger of straining investors’ credulity."
Patrick Hosking is Financial Editor of The Times