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Buying unlisted shares and AIF units a tightrope walk, retail investors should stay away

Distress sales of unlisted shares and alternate investment funds units may offer value. But the road is fraught with risks

April 02, 2019 / 09:28 AM IST

Ever noticed a tightrope walker? You could easily notice one at fairs in India, especially in villages. Sometimes, even carefully balancing a pot on his/her head and holding a stick to help maintain balance as he/she treads gingerly from one end of the rope to another.

It’s a high risk game! Fall and risk a fracture or break a limb. Reach the other end and earn admiration. You need nerves to even watch it.

Buying unlisted shares available in a distress sale is akin to a tightrope walk. Whether you simply buy the shares of unlisted companies that its existing investors want to sell or from an alternate investment fund (AIF) that investors wish to exit midway, or even shares held by employees — these are some of the opportunities that could prop up time and again.

If you’re vigilant, patient and have the money to spare there could be a fortune. But there’s no guarantee that you’ll make money here. And that is not just the only risk we’re talking about here.

What’s on offer?

In the financial markets, one man’s trash is another man’s treasure. If an investor is badly stuck with investments and is in need of money, then there is a chance that he/she would not mind exiting even at 20% discount to the fair value.

Since shares of unlisted companies are not listed on the stock markets, there is no market price. Instead, a fair value of the share is arrived at; more of that, later.

“If you have good connections across wealth management outfits then you keep getting deals frequently wherein investors are willing to exit at 20% to 30% discount. Cash in your hand is really a king in such cases,” says a wealth manager who does not wish to be identified.

Then, there are up and coming companies, typically of sunshine industries, that could get listed sometime in future. Nobody knows when, but some of these companies can get listed in future. In the meantime, they may offer their shares to some of their existing employees, in the form of employee stock-options, as a means to retain them.

When these companies do get listed and their shares fetch a good price, it helps existing employees to sell some or all of their existing shares at a premium.

Shares of unlisted companies especially the new age companies in financial services, e-commerce, non-bank finance companies (NBFC) are on the watchlist.

Some of the shares of unlisted companies that are traded include HDB Financial, Hero Fincorp, ANI Technologies (OLA), B9 Beverages (Bira), Mohan Meakin (Old Monk), One97 Communications (Paytm), Barbeque Nation and Zomato.

“Along with future earnings growth and the right buying price, the promoter’s willingness to protect the interests of the minority shareholders play a key role while choosing an investment in the space of unlisted shares,” says Shyam Sekhar, chief ideator and founder, of Chennai-based iThought.

If you invest in well-managed businesses with promoters who believe in wealth creation over long term and are willing to share it with co-owners – that is minority shareholders, then there is a fair chance of making money. Professionally managed companies, companies having non-promoter institutional holding are seen as less risky bets, though there is no sure success formula to ascertain promoter’s integrity.

Unlike listed stocks and mutual funds, you won’t get information very easily in this space. Nor would you have research reports from all stock brokers. You have to ask questions to the firm that is arranging these shares for you or the market maker, if any.

“The prices oscillate a lot depending upon the demand for and supply of the shares. Investors must ascertain the intrinsic value of the share and arrive at a fair value before investing. Otherwise, they end up buying something at a very high price just because it was in high demand at the time purchase,” says Haresh Nagpal, a chartered accountant based in Ludhiana.

As there is no formal market for these stocks, liquidity is a serious issue and one should never overlook. In the past, many such companies later announced initial public offers (IPO). That made many investors rich.

Shyam Shekhar is one such person. He could see prices of shares of ICICI Lombard quadrupling as it went for IPO. He also remembers an 80% price hike in over two years in share price of ICICI  Prudential Life Insurance.

Then, there are AIFs; these typically has a lifespan of five to seven years and the same can be extended by a year or two. The idea is to invest in the first three years of the fund and then reap the benefits of the investments over the remaining lifespan of the fund. A typical AIF may start seeing payback from fourth or fifth year onwards.

“Investors buying a unit of an existing AIF in its third year having a tenure of around five to seven years have better visibility of earnings as compared to investors who invest at the beginning of the AIF,” says Krishna Raghavan, founder and deputy CEO of UnlistedKart, a firm specialising in pre-IPO shares and secondary transfers having offices in Bangalore and Mumbai.

When an AIF starts, all its plans are on paper and it invests in various opportunities and tracks the growth and takes corrective actions. An investor who is investing mid-way knows how the fund has done so far and has a clear idea of how the things are working out.

If at this juncture if one gets to invest at a massive discount to the fair value and decent visibility of future then there could be a glimmer of an opportunity here.

Units of AIFs floated by IDFC, Carpediem Capital, Motilal Oswal, ASK are being traded.

Understanding a distress sale

Before we get into it, one should look at opportunities in the secondary market in such exotic investment options, let’s understand why they exist in first place.

Many a times investors underestimate liquidity. In times when you need cash, you wish to sell your investments. Since these type of investments are meant for high networth individuals and typically there’s a large chunk of money in such securities, investors rush to sell if they need the cash. That’s a big reason why investors with shares of unlisted companies try to sell them albeit at a discount.

At other times, an asset class may not have done well so far and may not be expected to do as well in near future too. AIFs that invested in real-estate sector are an example.

AIFs require a minimum investment amount like Rs 1 crore. Investors are expected to give money in tranches over a period of, say, three years. Sometimes investors sign up with an initial payment of Rs 25 lakh but later go back on their commitments due to paucity of funds or some of reasons mentioned earlier.

But the fund’s investment activities can’t stop for a few investors’ inability to pay up. In such ‘default cases’ it becomes necessary to give exit to such investors by bringing in new investors at a later stage.

“Many of these exotic investments are showcased to investors as a symbol of exclusivity though some of the themes are already available on mutual fund platform,” says Ranjit Dani, founder and director of Think Consultants – a wealth management firm based in Nagpur.

Dani also cautions investors that since commissions from selling MFs are falling, many distributors try and sell these exotic products to investors because they pay higher commissions.

Should you buy?

“If you are a trader then unlisted shares are not your cup of tea. It is a game best played by long term investors,” says Nitin Rao an investor based in Mumbai and founder of Alpha Ideas, an investment blog for Indian markets.

Most of the names in the unlisted shares space that are traded are in the initial years of the growth. If you understand the size of the opportunity and are happy to watch your investments grow over long period of time, then you should be investing in these companies.

But it’s not that easy. Beware of the counterparty risk, which means you may transfer the funds, but there is no guarantee that you may get the shares.

“Investors must insist on signing a memorandum of understanding before initiating any transaction. It clearly defines the transaction and protects rights of the parties involved in the transaction,” says Krishna Raghavan.

Another risk of buying unlisted shares on the hope to cash out on IPO is that the IPO may not happen anytime soon. There is no guarantee about the IPO. Also there is no assurance that you would get an exit before IPO comes.

“Come with a mindset to hold your investments for five years. If IPO is announced then you get an exit. Also you can sell your shares one year after listing,” says Nitin Rao.

“There are instances of IPO not making money for you,” says Haresh Nagpal. He points out that some investors bought shares of MSTC, ahead of IPO at around Rs 400. The IPO came at Rs 120. “You have to be a savvy investors to make money in such investments. If you are done with normal financial planning and want to put some money in high risk high return category then you may consider these investments. Otherwise just stay away.”

The net asset values of AIF must also be taken with a pinch of salt. AIFs make assumptions like how much cash underlying companies are expected to make, but these factors are susceptible to change.

Understand the underlying assets before investing. “Real estate sector is in poor shape. Developers’ are carrying very high inventory of unsold real estate and investors are not yet selling out in panic. Over supply should ensure that real estate sector won’t see uptick in near future,” says Ranjit Dani.

Finally, illiquidity is the big and obvious risk here. Unless these companies get listed, they continue to suffer from illiquidity.

“AIF may extend the tenure of the fund by a year or two. Investors should also understand the charges associated with each scheme, as post tax and post charges returns matter for investor and not the valuation at which AIF exits a particular investment,” says Abhishek Gupta, founder and chief financial planner of Moat Wealth Advisors. He recommends investing in such opportunities if and only if you have completely understood the portfolio and risk reward associated with it.

All retail investors, stay away.

For those who have the cash; unless you have a trusted advisor who takes on the responsibility for scouting of such opportunities (for a fee of course; a costly affair), avoid buying unlisted shares. If you must, ensure that your existing portfolio is well-diversified. And do not invest more than 3-7% of your investments in such exotic investment avenue, say investment experts.

Nikhil Walavalkar
first published: Apr 2, 2019 09:28 am