Earlier this month the Financial Conduct Authority published a discussion paper on the possibility of introducing a new type of fund that invests in illiquid alternative assets such as infrastructure, real estate, private equity and debt, and venture capital. But it is already possible for private investors to access these types of assets via investment trusts.
Most investors should have a diversified portfolio and alternatives are a way to diversify away from equities. “It used to be the case that when equities were bad, bonds were okay,” says Daniel Lockyear, senior fund manager at Hawksmoor Fund Managers. “But this is not likely to be the case going forward because of low interest rates and bonds not necessarily providing diversification. However, an allocation to alternative assets reduces your reliance on the direction of general financial markets, and as there are questions on whether we are close to the end of the equities bull market there is an argument for getting exposure to alternative [less correlated] assets.”
Over the long term, areas such as private equity could make strong returns and you may find opportunities among unlisted companies that are not available on public markets, for example in areas such as biotechnology and technology. Property and infrastructure, meanwhile, can deliver an attractive income stream. For greater detail on the benefits of alternative asset investment trusts see our articles on these themes in the funds section at www.investorschronicle.co.uk.
Investment trusts can hold assets that cannot easily be bought and sold because they have a fixed capital structure. When investors want to take their money out of an investment trust they cannot ask the fund provider to redeem their shares – as with an open-ended fund – they have to sell their shares on the secondary market. This means managers of investment trusts can hold assets for as long as they need to and are not under pressure to sell them to meet investor redemptions.
Having to sell assets to reimburse investors taking money out has been a problem for open-ended property funds. During the financial crisis and in 2016 after the vote to leave the European Union many investors wanted to take their money out of open-ended property funds, which could not sell the buildings they held quickly enough to get together the necessary money. So on both occasions they had to suspend redemptions for a few months, although went back to normal trading thereafter.
But just because investment trusts do not have to meet investor redemptions doesn’t mean they are low risk. A fund’s risk largely comes down to the nature of the assets it holds, not how soon you can dispose of your investment in it.
And although in theory you could sell your shares in an investment trust at any time, there isn’t a guarantee that you will be able to – you need another buyer. As a private investor, this is likely to be less of a problem as you are probably selling a small holding and should be able to trade it via a broker. But if the trust and/or its assets are unpopular you won’t get a good price when you dispose of your shares. Even if the underlying assets are doing well, if sentiment turns against them or the trust its share price will fall – and it is the share price not the net asset value (NAV) return that you get. Also, if the trust is trading at a premium to NAV this may fall to a discount, and if it is already on a discount this may widen further.
For example, property investment trusts experienced severe share price falls and swung out to double-digit discounts to NAV in 2008. In December that year the sector-weighted average discount for UK direct property investment trusts went as wide as 49 per cent, with some individual trusts on discounts in excess of 70 per cent, according to Winterflood Securities. So would you want to sell at this level? It would probably make sense to wait for a recovery in the trust’s share price and rating.
This doesn’t mean you shouldn’t invest in illiquid assets, but if you do so you should have a long investment horizon. “If you have an investment time horizon of less than three years you should not have much in alternatives or equities – if any at all,” says Mr Lockyear. “And ideally you should hold alternative assets for longer than five years.”
Dennis Hall, chief executive officer of Yellowtail Financial Planning, adds that you might have to wait 10 or more years for investments in alternative areas such as private equity to come to fruition. If you can’t wait you may get less for your investment trust shares than you paid for them, or probably not the best price possible. So don’t think of investment trusts as a liquid way to access illiquid assets.
You are also likely to experience volatility – even without extreme events such as the financial crisis. “Only invest in this area if you are not fearful of very large swings in price,” says Mr Hall. “Because the market itself doesn’t know how to price these trusts' underlying assets when it becomes fearful, it is extra fearful, and when it is exuberant, it is extra exuberant.”
Alternative assets can be high risk. For example, an unlisted early-stage company might not succeed, so all of the money that goes into it might be lost. For this reason, Mr Hall says it is important that the alternative asset funds you invest in are diversified, and you should hold more than one fund so you are not only relying on one manager. You should be prepared for substantial losses, a reason why you should not allocate a large proportion of your overall wealth to such areas.
An option for smaller portfolios could be a fund that invests in a basket of alternative asset funds, giving you diverse exposure via one holding. Options include Miton Global Opportunities (MIGO) and Henderson Alternative Strategies Trust (HAST).
Investment trusts can gear (take on debt) to take advantage of additional investment opportunities. However, if a trust is highly indebted this can exacerbate losses in falling markets.
“If you invest in alternative assets you need more focus, as it requires constant monitoring and better understanding,” adds Mr Lockyear. “You need to watch discounts and be aware of what's going on in the underlying portfolio. And if you don’t understand what it invests in, don’t buy it.”
You also need to ensure the trust you invest in is run by managers experienced in this area as they are more likely to make good returns.
If a trust invests in a fairly new or unproven asset class it might be a good idea to hold back and see how it plays out, and allocate to established alternative assets in the meantime.
Trusts focused on alternative assets also typically have higher charges than those focused on mainstream equities. This is partly because investing in real assets can be more expensive, but even so make sure you are not paying over the odds – especially if for the time being your alternative asset trust isn’t making good returns.
Just because you can invest in illiquid alternative assets doesn’t mean you should.