Asset Allocation

WeWork put its Initial Public Offering on ice this week as the company realised it would not be valued at the $47 billion that WeWork wanted. Indications are that WeWork would struggle to raise money with a $15 billion valuation.

The process WeWork took to get a $47 billion valuation is instructive for anyone with money invested in a Superannuation fund with significant unlisted assets.

WeWork is an unlisted company. Which means WeWork is not traded on a stock market, instead it is owned by a small number of investors. It also means WeWork traded infrequently - in this case, whenever WeWork needed more money.

The problem is that valuations were done by WeWork or a handful of investors based on what they thought they could eventually sell WeWork for. One major investor in WeWork, Softbank, has booked significant favourable investment performance based on the increase in theoretical value that Softbank imagined had occurred. Now Softbank will need to reverse those gains.
For investors trading in or out of Softbank in the meantime, it is a problem as the billions of dollars of gains simply weren't real.

A similar situation faces much of the Superannuation sector. Now I'm not suggesting all unlisted assets will need to be written down by two thirds like WeWork. But I am saying we just don't know whether the reported performance is accurate or not.

As I wrote earlier this year:

This is the issue when comparing funds that invest in listed assets vs ones that invest in unlisted assets – you have no way of knowing the actual value of the unlisted assets. A great example is unlisted property funds during the financial crisis. Unlisted property funds invest in effectively the same assets as listed property funds, the underlying properties are worth the same, the performance differs because of how it is reported:

Do you really think that while listed property prices fell almost 60% over a year, unlisted property prices had increased slightly over the same year? They both own the same buildings, it is just that unlisted assets don’t get valued regularly and so the values being reported were the values from prior years and didn’t reflect the actual market value.

By this stage, unlisted property funds weren’t trading anyway and so you couldn’t sell your unlisted asset at the inflated made-up prices – who would want to buy unlisted property assets at last year’s prices when you could get listed property assets at almost 60% off?

So, this is the trillion dollar question. Is an unlisted property trust less risky than listed property? There are a lot of people who say yes as the reported prices are less volatile – but my emphasis on the word “reported”.

For me, if it is the choice between owning an asset:

  1. in a listed vehicle where I can see what is happening, how much it is worth and buy/sell at any time, or
  2. in an unlisted vehicle where I don’t know what is happening, the asset can only be sold at infrequent intervals and the valuation is a mix of prices from prior years and management estimates

then I will take option 1 every time. Just because I can’t see the price move doesn’t mean that it hasn’t.

On average, Industry Funds have about a quarter of their assets invested in unlisted assets. For some, the figure is much higher. Which means the level of uncertainty is higher.

With full disclosure, some of my rant is probably sour grapes! We run superannuation funds at Nucleus, and it is all in liquid listed instruments - investors can see each and every underlying holding. We don't have anywhere to hide. Some months I wish we had 25% of assets in unlisted funds that could be strategically revalued...

Justin Sazegar

The flipside of this argumemt is whether the value of the properties actually fell by 60% and subsequently increased by 150%. Or was it driven by fear and greed in the market at the time. I think the latter. Overuse of unlisted assets may be a red flag, as we saw with Blue Sky. However, listed assets are prone to bouts of paranoid and hysteria, which can be unhelpful to investors without the stomach for it, as we saw with Centro Properties, which eventually went bust.

Jonathan Rochford

On the money commentary Damien. Unlisted real estate and infrastructure assets have done very well as interest rates have declined. Suffice to say, if rates go up they will take substantial pain and there will likely be a gap between the rate rises hitting listed assets and the mark to model changes for unlisted assets.

Damien Klassen

Justin: Absolutely valuations were driven by fear. But if you were an investor in listed property and you needed the money then you had to sell at a loss of 60%. If you owned an unlisted fund then the fund claimed that your money had increased, but they locked it up and you couldn't access it at all... for the investor that needed the money (say in a pension phase), the loss of 60% was way more real than the paper increase in a locked up fund.

Michael Whelan

Damien - Thanks for the article. If I recall correctly, MTAA Super had an 'ugly' year c. 2008/09 due to an overload of property and infrastructure assets. Notwithstanding the GFC, etc, I think we saw the market putting an indicative price on liquidity - or lack thereof.

Andrew Maloney

Mark your Own Homework This will be the next superannuation royal commission - how did we let our nations savings end up in a pool of "mark your own homework" super funds? - People in Sydney are watching entire apartment buildings falling apart because NSW thought builders should "self certify". - The entire US CDO crisis was based on paid ratings by ratings agencies, where everyone got a AAA. - The labour party in Britain wants to re-nationalise water infrastructure - but its owners value it at 3x what the government says its worth. The owners: Australian super funds. And now a second layer of this slow moving disaster may be happening. Australian super funds are so addicted to "mark your own homework" assets (PE and infrastructure) that they are falling over each other, and bidding against each other, to get new ones - pushing prices up. I spoke to a Macq exec recently and he said he's seen some mind boggling bids - and Macq was famous for being the home of the mind boggling bid. Paying people to value assets is a sure recipe for over valuation - even if all actors individually feel they are acting in good faith. It's the same as builders self-certifying or kids marking their own home work. It's nuts. It's the next royal commission. Disclosure: I run a public offer super fund with 100% market traded assets to ensure 100% transparent valuation to members.

Jerome Lander

Some great comments and a really important point raised by this article. Having come from working in the institutional market (admittedly, several years ago now), I understand that the "mark to make believe" valuations are very popular with large super funds, for a number of reasons - some of which might reasonably be argued are not in the interest of their members, but are in the shorter term interest of the staff. Delayed valuations can act in the interest of the agents or the internal investment staff, for example by (enabling them to keep their jobs longer) by delaying or preventing price discovery and reducing transparency, and enabling them to leverage risk asset exposures to compete in performance orientated league tables (which don't report properly on the risk taken to achieve their results). Of course, without an understanding of risk, what does return mean? But that is another point.). Arguably one could cynically consider the preference for unlisted assets a copycat strategy from the private equity market. Imagine two private equity funds who are 'friends'. They each sell an asset to the other one at an inflated price, and both assets are now marked up at the latest sale price. Both funds report a valuation uplift and strong performance - and are hence able to raise new funds, given past performance sells (whether it is real or not). Do you not think this happens? There are probably enormous numbers of unrealistic valuations and many frauds in private equity and unlisted land. WeWork is a flagship example of an alleged fraud that couldn't stand up to public market scrutiny. Without being in properly functioning listed markets, there is much danger for investors in believing that the the unlisted assets they pay for will be able to be exited at the same price to a fully informed market. Last time I checked, super funds don't openly provide the valuation methodologies they are using to the public for unlisted assets - so that they can be scrutinised by informed industry participants and competitors as to their "realism". Buyer beware indeed.

pete lynch

Damien - agreed. However, I guess that must also work the other way. As interest rates have fallen heavily, listed Infrastructure and Property Trusts have increased in price substantially as investors have sought yield. On the other hand;unlisted infrastructure and property have not been 'marked to market' due to the delay in revaluing these assets. I have both in super as individual assets and neither has moved up much at all as interest rates have continued to fall, while their listed counter-parts have increased in price strongly. As such, aren't these unlisted assets lower risk and actually have lower/better valuations than the listed assets, and as interest rates continue to fall make them even more safer and better valued investments than listed? Well until the narrative changes.