There's more than meets the eye in this year's rally. 'Growth capital' funds focused on private companies have staged a fierce comeback this year. Which names from the sector look unjustly cheap? The wonders of mean reversion can sometimes cause your worst investment in a given period to later come out on top. That’s arguably the case for investment trusts in the AIC’s Growth Capital sector, which tend to focus on unlisted companies reaching some degree of maturity. Growth Capital is the third-strongest category out of 48 based on its average share price total return over the first 10 months of 2024. Investors should, of course, note that the group ranked 48th in 2022, via an average loss of over 50 per cent. But there is also an investment rationale behind the recovery, which seems logical enough: these trusts have weathered the worst in terms of interest rate rises, which tend to hurt the valuations on the long-duration assets they own while making it harder for such cash-hungry companies to secure financing. With rates easing off, trusts trading on more attractive valuations, markets looking healthier and portfolio companies hopefully having grown more resilient in tough times, the conditions were in place for a rebound. Plenty of these names have made enormous gains this year, with Seraphim Space (SSIT) notable for a 36 per cent return, Molten Ventures (GROW) making more than 20 per cent and even Chrysalis (CHRY) posting a double-digit gain despite some fresh portfolio setbacks in recent months. Not all names have done well, with ex-Woodford vehicle Schroders Capital Global Innovation (INOV) continuing to flounder, but what all of the trusts have in common is that they continue to trade on huge share price discounts to net asset value (NAV). We have written plenty about these vehicles in 2024 thanks to a raft of new developments, but with the end of the year drawing closer and valuations still seemingly cheap, it's worth reflecting on where the portfolios are and what, if anything, has changed this year. Investors have plenty to mull over, whether they are considering putting cash to work now or asking if it makes sense to bank some gains after a strong 2024. Our analysis, which excludes more esoteric sector member Petershill Partners (PHLL), will be depressing reading for the many investors who excitedly backed these trusts at the time of their initial public offerings (IPOs). Most of them are relatively new prospects, which meant they quickly found themselves faced with a higher-rate era. That has left Molten Ventures as the only trust to have produced a positive share price total return since its flotation. These figures may well convince some early investors to stay put rather than try to offload their stakes in the trusts, although the outlook for the different portfolios will of course play a big role in any such decision. And some arguably have a brighter future than others. Mick Gilligan, head of managed portfolio services at Killik & Co, is among those who view Seraphim Space shares as cheap when weighed against the fund's prospects. He adds that the economics in the portfolio appear to be improving. "The revenue growth of the SSIT unquoted portfolio looks healthy, and over time shares should reflect this via a better rating," he says. "Two portfolio companies, D-Orbit and ICEYE, saw a boost to their fair value following new funding rounds during the latest financial period, and the average fair value increase in valuations for these companies compared to their cost was more than two times." On top of this, Gilligan feels the trust's board has done well by (like many others) engaging in share buybacks, although he believes some partial disposals by the investment team would provide greater confidence in the NAV, a common requirement when it comes to unlisted assets. This all comes at a time when the space industry is generating plenty of hype, in part thanks to recent advances made by Elon Musk's SpaceX, including a recent success at 'catching' a booster rocket in its descent. But SSIT will demand patience for multiple reasons. For one, its huge discount to NAV hampers its ability to raise more capital and provide its investee companies with additional financing. On top of that, the immature nature of the sector and Seraphim's chunky position sizes make it risky and subject to significant volatility, as returns over the past few years have demonstrated. Seraphim is a concentrated affair, with its biggest position accounting for around a fifth of the portfolio and the 10 biggest holdings making up three-quarters of the fund’s assets. Such concentration is also common elsewhere: Chrysalis’s biggest position makes up nearly a third of the fund alone. As our second table shows, however, Baillie Gifford vehicle Schiehallion (MNTN) and two Schroders vehicles in the sector currently have a much greater level of diversification. Punchy tech plays are an obvious choice for trusts such as these, and Gilligan is a fan of Molten Ventures, whose last half-year update he describes as "encouraging". "The NAV dipped a bit but mainly due to forex," he says, before adding "the company is seeing a significant pick-up in exit activity and collected £76mn in cash proceeds in the period". Gilligan notes that the portfolio companies "remain active", with five raising capital or transacting at increased valuations in funding rounds. He expects the trust's hefty share price discount to narrow as more asset sales emerge. Note that the trust can be somewhat limited when it comes to its disclosure, however, with investors having to dig into its reports to assess the underlying portfolio rather than, for example, being provided with monthly updates on this front. The growth capital names have caused plenty of disappointment in their time, not least the disastrous performance of INOV in the years since its highly anticipated IPO as a Woodford vehicle. Big falls for Oxford Nanopore (ONT) and a downward revaluation for private holding Reaction Engines have hurt performance again in recent times, and the fund still looks a long way from a quick turnaround. Chrysalis, a controversial name for many reasons, also appears to be quite the mixed bag at best. It was having a strong run in 2024 until the emergence of problems at Wefox, a major holding and ‘insurtech’ play, which suffered a big fall in valuation on the back of trading issues and a restructuring. However, long-term holding Klarna has seen its valuation rise on the back of better times for listed peers, while a potential IPO of the company could help free up cash for the team to put to work. As mentioned above this is an especially concentrated portfolio, making it one for those investors particularly comfortable with risk.

What next for these investment trust growth plays?

Growth capital investment trusts have seen a strong recovery in the first 10 months of 2024, with some notable gains from trusts like Seraphim Space (SSIT), Molten Ventures (GROW), and Chrysalis (CHRY). These trusts focus on unlisted companies and have faced challenges due to interest rate rises, but with easing rates and healthier markets, their conditions have improved. Despite significant share price discounts to net asset value (NAV), some analysts view these trusts as undervalued with improving prospects.