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One of the biggest obstacles to investment
in the EIS sector is the lack of independent,
accurate performance information on
the underlying activity of EIS funds and
portfolios. Managers may release top level
performance, but accessing the performance
of individual companies held within a
portfolio can be challenging. Without this
information advisers and investors are
putting their money in a blind pool and
trusting that the manager will be able to
produce the kind of performance they
are promising, but with no verifiable track
record to assess the veracity of their claims.
At the moment, most managers are
prepared to share some top level
information: how much money they have
under management, how much they have
deployed and how many deals they have
done. It is also very common to come across
case studies of underlying businesses
that have been invested in, which bring
some life and colour to the abstract
investment process – and of course show
EIS investing in a very favourable light.
This cherry-picking of information
to share does not give investors the
accurate picture they need to make
systematic, objective judgments.
THE IDEAL
The holy grail of EIS performance
measurement would be a full performance
look-through for each fund.
The performance data would list all of the
underlying companies that have been
invested in, how much was invested, when
was it invested and an up-to-date valuation
(or price achieved on exit). This would allow
calculation of the performance of the
underlying companies and allow investors to
assess the fund manager’s style and see
which investments were driving the
performance
It would also capture how much cash was
in the fund. This shows if the manager is
deploying the capital or if there is a cash drag
on performance
Finally, the manager would need to
confirm that each of those underlying
investments had retained its EIS qualifying
status. Any loss of status would, of course,
have a big impact on the final returns to the
end investors
Performance would be calculated gross
and net of the manager’s charges
Presenting performance information
in this way would allow investors to
make meaningful comparisons between
funds. It is much closer to the way
mainstream equity fund performance is
presented and we believe that it would
invite much more new investment.
THE REALITY
As part of compiling this report we went out
to over 40 EIS investment managers asking
them what level of performance information
they would be prepared to share. Only six
managers responded. We asked if they were
prepared to share any of the following: fund
level valuations; fund level and company
level valuations on current investments;
fund level and company level valuations on
exited investments; or no information at all.
Most managers were reluctant to share
any information. However, there are
important and understandable reasons
why managers are reluctant to share
this level of detail. In many cases, the
exit from an underlying investment will
depend upon a sale: making the internal
valuation of the company public would
make negotiating the sale and achieving
the best deal for investors very difficult.
Depending upon the stage the underlying
companies are at, valuations can be esoteric
and open to manipulation. Valuation models
can be adjusted to give quite different
outcomes depending on the assumptions,
projections and methodology used.
In addition, EIS funds can have very
different investment strategies. A fund
with a focus on a particular sector, or
that is targeting a particular risk/return
profile will obviously have very different
performance results – returns, variance in
the valuations, timing of exits, deployment
of cash – to a fund that has different
objectives. This can make some managers
hesitate to share information as they fear
that their fund might appear to be under-
performing, when in fact, it is doing exactly
what it should do, based upon the strategy
and objectives of the fund. The key is to
always make sure that you are comparing
apples with apples – the same problem is
common in the mainstream fund sector,
but can be dealt with by grouping similar
funds in IMA sectors (for example).
Another difficulty for managers is that, to
date, there have not been that many exits to
report on, certainly for some of the newer
managers. And indeed, the exits themselves
are also more complicated than they look at
first glance. Most exits are asset sales rather
than company sales, these are quicker and
simpler (buying the assets is preferred as
a company purchase may mean taking on
the company’s liabilities as well). However,
this process attracts a CGT charge for the
company, which obviously reduces profits.
One final note: AIM listed EIS qualifying
companies will be obliged to provide a lot
more detail than non-listed companies.
This is one way advisers and investors can
ensure they can have more performance
related information on an EIS investment.
THE WAY FORWARD?
There are a couple of possible ways
forward from these challenges:
Carry on as we are. Not really a way
forward, but it is clearly satisfactory for a
number of participants in the industry –
particularly the current incumbents who
already have the largest market share and
don’t have much incentive to support change.
However, they run the risk of getting
complacent and being disrupted by new
entrants
Report top level fund performance. This
would allow advisers and investors to assess
and compare fund managers, but without the
look through to the underlying investments so
that they can see where that performance is
coming from. However, it does keep the
valuations of the underlying companies out of
the public domain, making negotiating sales
easier
Provide a full performance look through,
but only to selected parties on a confidential
basis. Perhaps organisations that control
significant amounts of investment capital such
as IFA firms and wealth managers could insist
upon access to the full performance look
through on the basis that they would keep this
information confidential. This would give these
firms a competitive edge, which means the
playing field is not level for all investors –
although these firms may argue this is simply
an advantage of their size and scale
Full performance look through. The EIS
managers and underlying companies will have
to accept that the valuations will be public
knowledge. Any astute buyer of these
companies would presumably have a very
accurate valuation of what they are about to
purchase anyway, so perhaps the argument
that putting this information in the public
domain makes exits difficult is a smokescreen
EIS managers are using to avoid further
scrutiny
CONCLUSIONS
We explored this topic with a number of EIS
Managers and other parties on this topic.
Overall, it seems that most of the operators
in this market are hesitant about being
first to report on their performance, as
understandably nobody wants to unilaterally
disclose performance information.
Overall, it will need a concerted effort on
behalf of the industry to reach a consensus on
this point. There will be an advantage for those
managers who do disclose more information
though – investors may give preference to a
manager who perhaps promised less or had
slightly worse track record, but was more
transparent about what they have been doing
with their investors’ money rather than a
manager who promised much but had little
verifiable evidence to back up their claims.
MEASURING PERFORMANCE
