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Should you invest in unlisted equities during a bull run


Robert J. Shiller is credited with coining the term ‘irrational exuberance’. He famously said, “It amazes me how people are often more willing to act based on little or no data than to use data that is a challenge to assemble.” A very apt example of this would be the way investors were queuing up to invest in pre-IPO (initial public offering) opportunities in the unlisted market in 2021. It seemed like, if one missed investing in such pre-IPO shares, it would be a lost opportunity.

Such a fear of missing out was not wholly unfounded. In calendar year 2021, when low interest rates and high liquidity fuelled the bull run, many IPOs gave spectacular returns. According to Motilal Oswal data, “As of 30 December 2021, out of the 65 IPOs in 2021, 45 gave positive returns, and 20 gave negative returns. 15 of the 65 IPOs delivered over 100% returns”. Due to such performance, getting share allotment was becoming difficult, and investors wanted to capture the upside. Investing in unlisted shares at the pre-IPO stage suddenly became a must-have asset class in 2021, giving rise to brokers who deal in unlisted shares. Here, share prices are negotiated in over-the-counter deals.

However, in 2022, things have changed with aggressive interest rate hikes globally and the cost of capital going up. Unlisted companies that were planning on IPOs have either delayed their plans due to downward revisions in valuations, or the IPOs are now happening at different valuations. This has put HNIs (high net-worth individuals) who invested in unlisted companies at the pre-IPO stage in a difficult situation.

Unlike stock exchanges for publicly traded shares, unlisted shares are dealt in private markets. Usually, the sellers are employees who own them through Esops (Employee stock ownership plans), angel investors, or existing VC/PE investors who want to liquidate a part of their holdings. For any investor who buys shares in a pre-IPO deal, there was a mandatory lock-in of one year till November 2021. Post that, market regulator Sebi (Securities and exchange board of India) reduced the pre-IPO investors’ lock-in to six months.

During euphoria, the private markets tend to be far buoyant than their public counterparts so there was a frenzy among investors to buy the likes of Paytm, PolicyBazaar, etc. For the pre-IPO investors in Delhivery, Paytm, PolicyBazaar and many such companies, another challenge has arisen. These shares are witnessing an increased supply as investors are rushing to sell the shares as soon as the lock-ins get over. For example, SoftBank just sold a large block in Paytm. Many institutional investors will be forced to sell, even if the prices are not something great to talk about as they have to show exits to their investors. Many employees will also look to exercise their option to sell some part of their Esops.

For an investor, there are lessons to be learnt about the risks of investing in unlisted shares. First and foremost, these opportunities are fraught with liquidity risk, as the liquidity event (IPO) may get delayed due to adverse market situations which can impact an investor.

Secondly, there is no mechanism for price discovery in private markets as the unlisted share price is far less correlated to fundamentals; this creates a more significant risk for investors buying at high prices. For instance, buying Paytm at 2,500 per share or PharmEasy at 100 per share. Non-availability of adequate information makes it tough to make an informed decision.

Private markets offer a distinct opportunity, too, but only for the sophisticated and patient investor. There are opportunities when markets are subdued, and one can capitalize on them by entering at a lower valuation.

Furthermore, investors can explore investment in unlisted companies having business models that are not available in the public markets. As always, asset allocation is the key and illiquid investments like unlisted shares should not be more than 10 % of your portfolio.

Rahul Bhutoria is director and co-founder at Valtrust

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