Recent research from Wins shows that all the new issuance since the start of 2013 has been in alternative investment trusts. £3.1bn has been raised through 16 IPOs. Of these, only two have not had an income mandate and the average yield target for the trusts has been 5.7%.
The C share market and other regular issuance has been slightly more diverse, but is still showing an 80/20 split in favour of alternative investment trusts over conventional investment trusts with private equity picking up more than the developed equity sector in total. Henderson International Income is one of the few conventional trusts to undertake significant capital raising.
This means investors have been putting money towards assets such as aircraft leasing, onshore wind farms and specialist loan funds. Almost without exception, these trusts take advantage of the illiquidity of the underlying asset class. Investors are still putting a premium on liquidity and therefore many less liquid assets classes still look attractively valued. Fund managers who have spotted these opportunities are using closed-ended funds to invest.
But there are perils for investors in this type of trust. One of the most important is valuation. If there is an illiquid asset, that may be traded over the counter or, like timber, seldom traded at all, realistic valuation can be challenging. Investors need to ensure that the fund manager has a robust valuation mechanism in place.
This is easier in some asset classes than others. For example, Ian Barrass, manager of the Henderson Select Value trust, says that there are internationally recognised standards for the valuation of private equity holdings but with assets such as timber, the valuation metrics are potentially more subjective. He will avoid trusts where he cannot get a proper independent valuation.
Also, if alternative investment trusts are small and the shares are illiquid, they may end up trading at a significant discount to net asset value, with no catalyst to realise that value. Again, Barrass tends to avoid those investment companies with less than £75m and also looks for companies where cash can be realised along the way. This may include distributions from the sale of private equity holdings, or a regular income from niche fixed income assets or similar.
The better managers have put mechanisms in place to ensure that discounts do not widen out too far. This may be a fixed redemption, buyback schemes, or continuation votes. As it is, the majority of the stronger income-generative investment trusts are trading at par, or even at a premium to net asset value.
These alternative investment trusts provide a means to achieve uncorrelated returns within a portfolio, particularly on the income side. The income generated from catastrophe bonds, for example, will bear little relationship to the equity markets. Areas such as private equity may have greater correlation, but should still be different in the longer-term. This is an increasingly important use for investment trusts and uses the structure to maximum effect. However, there are complexities of which investors should be aware.
