Past performance is not a guide to future performance.
Despite good progress, the Bank of England remains a long way off achieving its target 2% inflation rate, meaning any material reduction in the Bank Rate is unlikely in the short term. With interest rates high, over allocation to cash across a portfolio might be tempting, however this could be a short-term view which can lead to missed investment opportunities at attractive entry costs.
Richard Moore, Co-Head of Investments, gives his analysis on how the current environment may affect the investment decisions made and his outlook for the portfolio.
Do you agree with the FCA that a sharp rise in global interest rates is likely to lead to lower valuations of private assets? Why/why not?
A higher Bank Rate means the cost of capital is higher, which will moderate the valuations of all assets, including private companies. As EIS and VCT investors, we understand the long-term nature of the investments into private unquoted companies and have the flexibility to ride out periods of volatility. Such periods often present buying opportunities for experienced investors. High valuations and low cost of capital lead to optimal exit conditions for private equity and venture capital fund managers, and this was the case in 2021 and 2022 when we exited a number of our investments. The current market will encourage experienced investors and fund managers to find attractively priced investment opportunities in both public and private markets. There is often a time to buy and a time to sell. (Past performance is not a guide to future performance.)
How will deals struck in more exuberant times fare in a high-rate environment?
The funding environment for private companies has changed over the last 12 – 18 months. Investors are more focused on capital efficiency and the path to profitability than before the turn in the interest-rate cycle, when the pursuit of revenue growth was paramount. At Calculus, we have always prioritised the efficient use of investors’ funds, so in many ways the market has come to us. Crucially, the IP driven companies we invest in have the potential to grow significantly in value. Delivering on its business plans will have a far greater impact on their valuation than the change in the interest rate environment.
Will any particular sector of the private market be affected more than others? E.g. tech, life sciences?
When the cost of capital increases, the costs faced by the most capital hungry sectors increases by the most. Fast growing sectors – life sciences and technology – require significant capital and so their valuations have been most impacted. After a show of resilience to the pandemic and a particularly strong 2021, private markets have seen falls in value in the tech and life science sectors, although it should be remembered that this was after a period of significant gains. Both life-sciences and technology feature heavily in the investment strategies of many PE and VC funds and the decline in valuations has been widely reported. It is usual for there to be a lag between an increase in the cost of capital and the expectations of investors on the one hand; and the ambitions of companies raising funds on the other. This was particularly the case during the first half of 2023, although in recent months companies coming to market to raise fresh capital have become more realistic.
How important is diversification?
As with public markets, diversifying across sectors when investing in private assets is key to building a robust and resilient investment portfolio. Regardless of the prevailing macroeconomic conditions, diversification should always be strongly encouraged.