There are lots of clever dicks valuing private assets but not many clever enough to explain complicated things in a way simple enough for me to understand. Frederic Blanc-Brude is such a clever (person).
He’s written an excellent article in the FT on how USS and other pension funds between them lost up to £5.1bn of real money buying shares in Thames Water.
A simple explanation of the value of Thames Water
Blanc Brude’s explanation of why so many experts got it so wrong is simple.
The cost of capital in this investment should have been considered quite high (and increasing over the years) and its value much lower.
At the heart of the problem was a system called CAPM which allows investors to make valuations based on a view of the market as a whole and of the company’s capacity to out-perform the market Beta (the average performance)
Blanc Brude claims the scientific community has known for more than 30 years that CAPM, while one of the foundations of the field of academic finance, is wrong. The model used by most large valuation firms, many private asset managers and the regulators of UK network utilities has been proven not to work.
This being the case, you have to ask why the scientific community had not got through to the CIOs of USS and other large pension schemes likely to buy directly into the equity of private companies. For Blanc-Brude reminds us , with a directness I have come to expect from Con Keating but not from the private equity market
There is only one way for a water utility serving the capital of a G7 country to lose so much value so fast: it was never worth £5bn to begin with.
It would seem that some fundamentals have been left out of the valuation process, things that would seem obvious to us all. The debt in Kemble, the pipeline of fines , the debt in Thames Water’s two pension schemes.
I suspect that this is a case of theory taking over from common sense.
What is happening to this £5bn of predominately pension money is of course hugely important. If we cannot trust the valuations of the investments made by schemes we had better invest purely in listed securities.
Thankfully we do not have to invest by formula and we are now in possession not just of better information but of artificial intelligence to process it.
Lessons will be learned. Simon Pilcher, CIO of USS will have had sleepless nights over what is happening. it is hard to imagine that due diligence wasn’t done, but it’s impossible to believe that it worked.
But all is not lost, Thames Water is a business that should be our pride and glory. As I walked out on the Embankment this morning , I walked past London’s super sewer, in its final stages of completion.
The long term value of Thames Water is in/on our hands.