Asset allocation is the key to long term portfolio appreciation. Adding uncorrelated securities reduces the overall risk in an investment portfolio. Unlisted equities have surprisingly low price correlation with the listed ones. Hence including unlisted equities in the portfolio reduces the overall risk in the portfolio.
Many young companies grow much faster than mature companies due to their lower base and hence they tend to significantly outperform the benchmark returns. However, a lot of this growth happens before the company goes public with an IPO. Hence participating in such companies in the Growth / Pre IPO stage can provide superior returns to the investor and carefully chosen unlisted/Pre-IPO shares can give much higher portfolio risk adjusted returns than the benchmarks!
Risk & Risk Mitigation
While investments in Unlisted/Pre IPO shares have the potential of giving high returns, they are also accompanied by higher risk due to a variety of reasons like lower regulatory requirements, lack of liquidity, availability of information, higher mortality etc. Investors need to exercise caution while investing in Unlisted / Pre IPO companies.
Generally, they should have a minimum time horizon of 4 years and should not allocate more than 30% of their portfolio to Unlisted/Pre IPO shares. The key to the art of investing in unlisted shares is to identify companies with great business fundamentals and great corporate governance – one is useless without the other. Investors can use various proxies like the promoters’ track record, voluntary public disclosures etc to assess the corporate governance. A lot of research has to go into understanding the business fundamentals. Investors can also choose to invest only in companies with relatively larger market capitalisation (Say above ₹ 2000 Cr) and thereby mitigate the mortality risk while retaining the returns expectation.
All in all, if approached strategically, investments in unlisted equities can prove to be extremely healthy for an investor’s portfolio!