Off-road investing

The problem private investors have is that these alternatives have been difficult to access directly. However, via funds you can gret exposure to a wide range of areas.

This is often via investment trusts that are listed on the stock market. These are more suitable for investing in assets which are difficult to buy and sell, and need to be held for a long time to realise a profit, because listed funds do not have to meet investor redemptions as open-ended investment companies do.

You maybe familiar with established alternative asset classes such as infrastructure or private equity, but there are listed funds offering access to even more unusual assets. The problem with funds invested in more unusual assets is that they may be particularly high risk or very hard to get hold of, because their initial public offerings (IPOs) are aimed at institutions, and thereafter there is little trading of the shares. However, if you can get access, some of these areas could prove to be attractive. We set out some examples below.

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Litigation

Litigation funds make profits by providing finance for corporate claims before the legal process is complete, and sharing in the rewards if the case is won. The returns are not directly correlated to the stock market: one of the funds, Juridica Investments (JIL), says it is only loosely correlated to economic conditions and investments in corporate claims can be counter-cyclical to general economic conditions. It adds investments in corporate claims can make attractive returns against an uncertain wider market backdrop.

John Davey, an analyst at Investec, says: "Litigation finance is an area we like, as managers are often able to exhibit strong stock selection skills, essentially by only taking on cases likely to win."

"Win/loss ratios exceeding 80 per cent are often achievable, by contrast large cap stock managers achieve similar win/loss ratios of around 60 per cent.

"Our preferred option within the litigation finance space remains Juridica which has produced three year annualised returns of 9.1 per cent in net asset value (NAV) terms and 21 per cent three-year annualised returns in price terms."

Juridica invests in business claims and has 15 investments involving 20 cases in areas such as antitrust and competition, patents and general commercial litigation. Burford Capital (BUR) also focuses on commercial litigation rather than consumer lawsuits. In May 2013, Burford completed a reorganisation from its original investment fund structure to being a perpetual finance company. This included the acquisition of its investment adviser and was aimed at expanding its suite of investment structures in the US, enabling it to expand.

"One of the key differentiators between Juridica and Burford Capital is that Juridica pays out the net proceeds arising from maturing cases," says Mr Davey. "Juridica has a mature portfolio and recently highlighted an underlying holding, case 1208-A, which could potentially result in cash returns through settlement to the company in excess of 15 per cent of the current NAV."

However, Burford Capital and Juridica trade at a premium to NAV of 22.45 per cent and 10.26 per cent respectively. They also have very high ongoing charges: Juridica's is 3.36 per cent and Burford Capital's is 10.26 per cent.

How the litigation funds compare

Source: Morningstar

Performance data as at 3 June 2014

Peer-to-peer lending

Until recently peer-to-peer lending was an activity investors had to put their money into directly, whereby a website brings together a lender (investor) and a borrower, offering both parties terms that beat the banks. Lenders can earn between 3 and 10 per cent interest.

Read more on peer-to-peer lending

But last month an investment trust which invests in peer-to-peer lending, P2P Global Investments (P2P), listed in London. Its assets will have targeted returns of 5 per cent to 15 per cent a year. The assets will either be purchased directly, via peer-to-peer lending platforms, or through other funds managed by the investment manager. Investment will be focused on US and Europe, with currency risk hedged back to Sterling. The company targets a dividend of 6 to 8 per cent a year on the issue price, paid quarterly.

The managers have entered into agreements with platforms such as Funding Circle US (up to $5m), Funding Circle UK (up to $2m), as well as RateSetter, Zopa and Crossflow Payments, and it should be fully invested within nine months.

It yields 6.07 per cent but has already moved to a premium of more than 7 per cent.

Brokers at Numis say that "P2P Global Investments is an interesting addition to the listed funds universe, although we believe that it is currently difficult to assess the risk/return characteristics relative to other asset classes."

Listed debt fund GLI Finance (GLIF) is refocusing its portfolio on peer-to-peer lenders which facilitate loans to small to medium enterprises, with recent investments including UK companies FundingKnight and Platform Black.

The company aims for an attractive income, and as it is selling its loan portfolio, should be revalued and could achieve a decent uplift. It currently yields about 8 per cent though trades on a double digit premium to NAV.

GLIF holds the equity of the companies which makes these investments as well as loans.

Both of these funds are very different to direct investment in peer to peer, however. You are buying listed shares and the share price could move differently to the underlying assets. Even if the investments are doing well a sharp fall in markets, or if they fall out of favour with investors, could mean the price goes down.

P2P Global Investments also charges a management fee of 1 per cent a year, and on top of this can levy a performance fee. With both funds you have to pay broker or platform fees to purchase shares. This means it is probably more expensive than investing directly in peer to peer loans.

However, because your investment is widely spread across many loans and invests in the equity of the platforms as well, it may be less risky than direct exposure.

Aircraft leasing

A relatively new area among London listed funds is investment companies which lease aircraft to airlines over a number of years. There are four listed in London: Doric Nimrod Air One (DNA), Doric Nimrod Air Two (DNA2), Doric Nimrod Air Three (DNA3) and DP Aircraft 1 (DPA).

The main attraction of investing in aircraft leasing is a high and stable yield. The Doric Nimrod funds lease Airbus A380s to Emirates Airlines over 12 year terms, while DP Aircraft 1 leases two Boeing 787-8 Dreamliner aircraft to Norwegian Air, also over a 12 year period.

They offer yields of between about 3.6 and 7.8 per cent. Mick Gilligan, head of research at Killik, says this asset class is suitable for high risk appetite investors who need a high level of income, and could form up to 1 or 2 per cent of their portfolios. You should understand the risks and how these transactions work before you invest, and have a long-term time horizon.

At the start of the term the fund is highly indebted having bought the aircraft, though this reduces as it is paid down over the term and at the end of the period it is fully paid down.

The two key risks lie with the attractiveness and predicted residual value of the asset, and the financial strength of the lessee, the airline. If the airline defaults or becomes insolvent it would not pay to rent the plane, which would have be repossessed and released or sold.

The aircraft must be sold or re-let at the end of the transaction or this could cause a loss on your capital, as could also be the case if it is not sold or re-let for a certain amount, though your total return is protected by the high level of dividend. In the current deals investors are expected to come out with their capital value in tact as well as a generous level of dividend.

The Doric Nimrod funds are leasing their planes to Emirates for terms of up to 12 years and Marc Gordon, partner at Nimrod Capital, expects to sell out at a profit. Emirates bears all costs (including maintenance, repair and insurance) relating to the aircraft during the lifetime of the lease. "The Airbus A380 has a working life of 25 to 30 years because most of the moving parts are replaced regularly," he adds.

The market conditions at the end of the term for selling or re-letting are an important factor, as is the ability of the fund manager to do this.

Aircraft leasing deals are focused on only one type of asset, and the current deals only have between one and seven holdings in each deal, which adds in concentration risk.

No London listed aircraft leasing fund has yet fully completed a disposal of one of its aircraft. But Doric Nimrod has a consistently strong long-term record of implementing the strategy, according to Mr Gilligan, having launched 47 single plane companies on the German market, 19 of which have reached lease expiry and successfully completed re-leases or sales, providing capital uplifts.

The Dr Peters Group which launched the DP Aircraft 1 fund has launched 12 aviation funds on the German market having previously leased Boeing 777 and Airbus A380 aircrafts to Emirates, Singapore Airlines, Virgin America and Air France. These funds have not matured but all have been implemented successfully and produced returns in line with the forecast at outset.

The Doric Nimrod funds are trading at double digit premiums to net asset value (NAV) and to get the full benefit of the income you are best buying these deals at initial public offering (IPO). Esoteric funds tend to be traded less so it is not as easy to get the shares, and when you do there are wide spreads (the difference between the price you buy and sell at) making it expensive to enter. Mr Davey argues that it makes sense to enter these at IPO.

There are not any aircraft leasing IPOs currently announced, though there may be some later this year.

Nimrod also runs the Nimrod Sea Assets (NSA) fund which buys and leases ships to oil and oil service companies for offshore operations over a fixed length of time. It offers investors a high yield – 10.41 per cent - but trades at a premium to NAV of more than 8 per cent.

Funds of funds

Because of the difficulty in accessing esoteric investments trusts, and in some cases the high costs, an alternative way to do this might be via a fund of funds.

Two funds of investment trusts focus on investing in unusual investment trusts, Henderson Value Trust (HVTR) and Miton Worldwide Growth (MWGT). These have a number of advantages: with a purchase of a few shares in each you have exposure to a diversified basket of alternative investments, rather than concentration on just a few. As these are high risk areas this is an advantage: if one underlying holding had a particularly severe loss it only accounts for a small portion of the funds - both Henderson Value and Miton Worldwide have more than sixty holdings.

The funds are run by specialist teams who have been investing in esoteric assets for many years, know the risks and where to look. They also devote all their time to doing this.

Their ongoing charges are much lower than those on some of the underlying funds they hold: Henderson has an ongoing charge of 1.09 per cent, and no performance fee unlike some of its holdings.

Miton Worldwide Growth has an ongoing charge of 1.34 per cent, and can levy a has a performance fee of 15 per cent of any outperformance in the NAV compared to 3 month LIBOR + 2 per cent, though this is capped at 2 per cent of gross assets.

These ongoing charges are also a lot lower than you pay for many funds of funds, some of which have ongoing charges in excess of 2 per cent.

Both are listed on the main market of the London Stock Exchange, which has stricter listing rules than AIM or the Specialist Funds Market where a number of esoteric asset funds are listed, and are likely to be easier to trade than some of their underlying holdings.

However, because their investments are widely spread if one underlying fund does particularly well you will not profit as much as if you held it directly.

Miton Worldwide Growth targets funds and sectors its manager considers good value, typically with a visible catalyst to bring about a re-rating. It tends to lag in strongly rising markets but analysts at Cantor Fitzgerald believes it has the potential to perform strongly as sentiment recovers. With the underlying holdings trading on discounts as well, investors get a discount at both trust level and on some of the assets. It offers diversification, with a correlation of 0.6 per cent to the FTSE All Share over three years, in contrast to the Global Growth investment trust sector average of 0.95 per cent.

Henderson Value Trust has only been run by its current management for a year after its board decided to replace its former manager because of poor performance. The new managers are overhauling the portfolio over three years and performance has not yet turned up, with the NAV only up 1.1 per cent against 5.9 per cent for the FTSE World Index over the six months to March 31 – in part because of exposure to emerging markets and commodities. The changes are also being implemented at a measured pace so the managers can extract value from existing holdings and only invest in new funds that meet their criteria.

But they argue the new investments are performing satisfactorily and that some of the legacy portfolio will produce significant amounts of cash over the next one to two years for redeployment into good quality investments. "At some point our emerging markets and natural resources weightings will provide attractive returns when investor sentiment improves towards these sectors," they add. "Finally, our aim to increase the company's dividend yield is well on track."

Henderson Value Trust faces a continuation vote in December, which its managers admit is far from certain. If it were to wind up the difficulty in selling the underlying investments means it would not be straightforward, according to analysts at Winterflood. "Given these uncertainties it is difficult to make the case for Henderson Value Trust at present although we recognise that it does offer value," they say.

Read more on ways to benefit from investment trust corporate action

Read our interview with Henderson Value's manager

How esoteric funds of funds compare

Source: Morningstar

Performance data as at 6 June 2014