Looking for LBOW room

It started with shares in packaging maker Powerflute (POWR). With a dividend yield approaching 5 per cent on 2013's likely payout and trading at around 10 times forecast earnings, could Powerflute's shares be a useful addition to the Bearbull Income Portfolio, which must cut its exposure to animal feeds processor Carr's Milling (CRM)?

It's rarely sensible to get excited about anything in packaging, an industry whose pricing power is as feeble as that of a milk processor in the maws of Tesco. Sure, Powerflute's mill in Finland is one of only three Nordic suppliers of semi-chemical fluted packaging, which is especially suitable for transporting fruit and veg. Even so, contracts tend to be short, demand is tied to Europe's economic performance and there are always more ways than one to package apples and pears. That means that Powerflute's profits are likely to be volatile. So in calculating return on equity (RoE), it's fair to take average profits for, say, the past six years as the numerator. Using that number, RoE is just 8.7 per cent - quite plausibly less than Powerflute's cost of capital and certainly at odds with a price-to-book ratio of 1.4 times with the share price at 24p. True, I haven't crunched the numbers, but unless market value fell close to book value - ie, 17p or so - there does not seem much point.

Next, I remembered I had meant to run the rule over Starwood Europe Real Estate (SWEF) and ICG-Longbow Senior Secured UK Property Debt Investments (LBOW). These two - both of which got their London listing only this year - aim to profit from the funding gap left by the retreat of banks from commercial property lending. Both should be fairly low-risk vehicles, although Starwood may be slightly racier. Its loan portfolio will range around Europe (while LBOW's will be predominantly UK); it will put capital into 'mezzanine' finance (while LBOW will stick with loans); and, on average, Starwood's portfolio will lend up to 75 per cent of the value of its underlying properties (while LBOW will lend a maximum of 65 per cent of each mortgaged property's value).

That said, there is minimal difference between each company's targeted returns. Their definitions may vary, but Starwood aims for an 8-9 per cent return, while LBOW goes for 8 per cent. Yet their dividend targets make them interesting - and contrasting - investment propositions, as illustrated by the table. The shares of both companies are slightly up on their placing price - 100p in both cases - and lower-risk LBOW offers usefully more yield in year one, but almost a percentage point less - or about a seventh less - thereafter.

That gives me a problem. The rule I set for new entrants into the income fund is that their purchase-price yield must be 1.2 times that of the All-Share index, which currently means about 4.5 per cent. Starwood's yield is well short of that threshold until it is fully invested, while LBOW almost scrapes through. Clearly I would prefer Starwood's 6.6 per cent yield in the longer term and feel relaxed about the extra risks in its fund. So do I simply ignore my own rule? I could do, but it's there to protect the high-yield status of the income fund.

Then it dawns on me that there may be another way - what about shares in the company that effectively runs the LBOW fund, Intermediate Capital Group? They easily qualify, with a yield of 4.7 per cent for 2013-14 on City estimates. LBOW is the way that Intermediate Capital's bosses want to go - less investing their company's own capital in risky mezzanine situations, more becoming a manager of debt funds.

If nothing else, that fulfils the first rule of capitalism - you get rich using other people's money, not your own. More seriously, fund management generates a smoother income stream than being the principal in funding deals. That's really risky, as illustrated by Intermediate Capital's record since the collapse of Lehman Brothers. As recently as the first half of 2012-13, profits were savaged by £65m of loan impairments. That was particularly high, but Intermediate's boss, Christophe Evain, warns that over the long haul the group's investment side will have to write off 2.5 per cent of its assets.

Even so, Intermediate's share price has rebounded strongly and, at 435p, it's at a post-Lehman high. It's also 18 per cent above its latest figure for net asset value (NAV). That's as wide a premium as it gets, which is reason enough to hold off buying the shares. Pity. Still, Intermediate's is a volatile share price - the beta is almost 2.0 - so if, or rather when, the price drops back to NAV or less, that should be a good time to strike.