volatile valuations leave trusts livin’ on a prayer

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Measure a business not by what has been put into it, but what can be taken out. Shareholders of the Hipgnosis Songs Fund and Scottish Mortgage Investment Trust will greet Benjamin Graham’s quip with a grim smile.

The respective share prices have fallen much more than their net asset values. Differing approaches to valuing their private assets are the cause.

Publicly traded investment vehicles holding private, illiquid assets create a mismatch. That risk will suit some shareholders seeking exposure to areas with high growth potential. But low interest rates can inflate private asset valuations. Both companies reflected this issue in separate announcements on Monday.

Hipgnosis, a controversial investor in song rights, suffered when the risk-free discount rate used to calculate its portfolio value rose with interest rates. The optimism of Citrin Cooperman, a specialist valuer, had already provoked scepticism. It had applied an unwavering, standard discount rate of 8.5 per cent to disparate music assets. Tracks by Rihanna got the same treatment as those by Bon Jovi.

For this and other reasons, the market applies a 50 per cent haircut to the trust. Net debt of £449mn, as of March, looks steep against forward ebitda of £86mn. To Graham’s point, shareholders may soon find out where value really lies. They have voted against a continuation of the fund and thereby a potential sale of assets.

SMIT, famous for big investments in US tech, also uses third-party valuers, in the form of IHS Markit, to price substantial private investments. But it too has struggled to convince shareholders these are correct. The discount to NAV is nearly 20 per cent.

SMIT has therefore given more detail on the financial performance of its top 10 private holdings. That helps clarify the differing impact of interest rates and underlying income growth. Better late than never.

The lesson painfully learnt by Hipgnosis and SMIT is this: ensure that these valuations are as clear, conservative and robust as possible. Promoters of new investment companies, please take note.