Inflated valuations are not trickling down to private equity

Small-cap private equity markets are not experiencing the same level of inflated valuations as seen in listed markets despite low interest rates and high fiscal stimulus spending.

Speaking to Money Management, Claire Smith, Schroders alternatives director, private assets, said there was still a trickle-down effect in valuations taking place in small-cap private markets but not to the same extent as listed companies because private equities were harder to access. 

“You can’t just go on your phone and buy some shares the way you can with listed markets so [there] hasn’t really been that flush of money going into it,” she said.

“And even if you read stuff at the moment about the bids for Sydney Airport to take it private, that’s nowhere near the type of scope of companies we’re investing in.”

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She said private equity funds were also better positioned to capitalise on healthcare opportunities, which were trending in the market.

This was due to the fact they could access up to 145,000 firms across Europe, the US and Asia compared to just 2,600 in listed exchanges.

Smith said Schroders’ private equity fund, which invested in smaller sized companies, was one of the only private equity funds that could be accessed by retail investors.

“Traditionally it’s only really been available for institutional investors because you have a 10 or 12 year lockup and your minimum fund investment is usually between $1 million and $5 million,” said Smith.

“For individuals, that’s out of most of our reach so we created a fund that has more liquidity than that so you can redeem your fund units on a quarterly basis.

“So, if you decide at the end of December that you want to redeem, you get redeemed at the end of March and you get paid out a month after that.

“It’s still quite illiquid versus traditional ASX 200 funds where you can get your money out within three days or so.

“But when you compare it to other forms of accessing private equity where your money is locked up for three to 10 years, it’s quite appealing.”

She said she was seeing more advisers wanting to implement it into their client’s self-managed super fund solution because they were more comfortable trading off liquidity for returns in their super accounts.

“It's just the breadth of access you can get to different companies as well as the fact that we're still able to buy companies at much lower multiples when you compare them to listed markets which are trading at pretty exorbitant prices in the context that we had a recent recession,” Smith said.

Valuations in her fund would be less negatively impacted if interest rates were to rise as listed companies, according to Smith.

“We are valuing companies at their kind of theoretical price and one of the ways you can do that is a discounted cashflow methodology where you predict the cash flows that are going to come then you discount rates,” she said.

“If rates go up, the economic thesis says company valuations will go down because of that relationship.

“But we’re also in a pretty small end of the market and because the fund is not listed, you don’t have people trading intraday.”

She said changes in valuations in private markets were more muted than listed markets and were less impacted by movements of capital.

“We don’t always use discounted cashflow methodology. Sometimes you value based off revenues versus costs and if the company is still producing the same level of revenues, it might not impact the pricing that much so you lose a lot of the noise that you see in listed markets when you see bond yields jump and suddenly equity prices move really quickly in response.

“So, you lose all that in private equity because you are just fundamentally valuing the company based off its revenues, expenses and all the normal basic stuff.”