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Alternative income trusts: what next?

Looking beyond the most obvious winners
September 16, 2020

Global dividends fell by a fifth in the second quarter of 2020 and any wholesale return of equity income continues to look like a distant hope. While companies such as Persimmon have raised eyebrows by reinstating their payments, they remain firmly in the minority. Continued uncertainty and the likelihood of economic pain further down the road suggests that dividend income is still a long way from its pre-Covid levels.

Against this backdrop, alternative asset classes and the investment trusts that focus on them continue to stand out. Areas such as infrastructure offer a reliable income, diversification from equity market volatility and even an element of inflation protection. As we discussed in April (Big Theme, 17 April), popular alternative income plays recovered from the Covid sell-off relatively quickly and have powered ahead since.

But like the equity market, the alternatives universe is now clearly split between the winners and losers of the pandemic. If the losers look unappealing to most investors, winners such as the infrastructure funds often trade at large premiums to net asset value (NAV). Anyone looking to up their alternatives exposure as a source of income must therefore think carefully about what price – or risk – is justified in the hunt for a good yield. It is also important to diversify across different alternative assets where possible, and not forget the need for due diligence.

“There’s lots of work do on the trusts now rather than buying just on discounts and yields,” says Daniel Lockyer, senior fund manager at Hawksmoor. “Discounts might be deserved or there might be an opportunity. Investors need to do more work than they have done in the past. Board behaviour is another factor.”

He highlights instances, for example, where boards have declined to use cash to buy back shares when they continue to languish on a discount. In the case of Real Estate Credit Investments (RECI), Mr Lockyer argues that the board “hasn’t covered itself in glory” by not buying back shares.

Similarly, as popular asset classes mature and established trusts face more competition it may be worth considering some of the newer income plays available. As City Asset Management research director James Calder puts it: "You have to ask with this sector if the amount of assets and choice increases, you might see pricing pressure on incumbents. We might sell down some incumbents and buy newer names."

 

Safety in diversity

Mr Calder suggests that many alternative asset classes are “mutually exclusive”, in the sense that they are not correlated to one another. As such, it makes sense to allocate to a few different sectors for income if possible, as well as keeping an eye out for new offerings.

One trust with a compelling proposition is Hipgnosis Songs Fund (SONG), which focuses on music royalties. The trust can benefit from the long-term trend of music streaming, and provides a source of income and total return with little relation to the ups and downs of markets and economies or the fortunes of other alternative assets.

James Carthew, head of investment company research at QuotedData, argues that the trust is “going from strength to strength”, from recently buying a US firm with a catalogue management business to making a number of senior hires. He does add that Hipgnosis has started to look “more like a record publishing company than a royalties fund” recently because of a focus on song creation, though the jury is out on how this affects the investment proposition itself.

Meanwhile, specific names in more challenged sectors continue to stand out. Leasing funds have tended to struggle because of a focus on areas such as airports, but commentators highlighted Tufton Oceanic Assets (SHIP) as a name that might appeal for patient investors. It has traded on a hefty discount, something that Mr Lockyer puts down to concerns about the global economy, shipping rates being low and a need for the trust to renew some of the charters on its ships. “They could potentially be negotiating new charters at low rates,” Mr Lockyer says. “They say they will put them on short term deals at cheap rates and then go back to normal rates later. The market is rightly concerned about that, but it’s good in the long term.” The trust’s shares recently yielded some 8.5 per cent.

Similarly, Biopharma Credit (BPCR) continues to stand out in a troubled debt space, though its shares command a premium. The fund, which lends to life science companies with the debt secured against revenues on approved products, has remained fairly resilient this year.

In the specialist property space, Home Reit is a newly established trust looking to raise £250m to build a portfolio of homeless accommodation in the UK. It will target a yield of 5.5 per cent on the initial issue price and a total shareholder return of 7.5 per cent a year in the medium term. Its prospectus was due to be published on 22 September.

As we noted in a recent Big Theme (14 August 2020), property is an asset class that illustrates the divide between 2020’s winners and losers. Social housing names such as Civitas Social Housing (CSH) and Triple Point Social Housing (SOHO) have held up well in terms of rental collection, and have stable, government-backed income. Healthcare names such as Target Healthcare (THRL) and Impact Healthcare (IHR) have also fared well, as have logistics trusts such as Supermarket Income (SUPR). But they tend to trade on premiums, while trusts with exposure to vulnerable industries such as retail languish on enormous discounts to NAV. Judging your entry point for the winners, or being careful about taking a contrarian bet on “cheap” trusts, can be useful.

 

Infrastructure: Pay to play?

Generalist infrastructure trusts such as BBGI (BBGI), HICL Infrastructure (HICL), GCP Infrastructure Investments (GCP) and Sequoia Economic Infrastructure (SEQI) have continued to look strong on a portfolio basis. While some infrastructure assets such as toll roads have been affected by the Covid-19 lockdown and a general fall in activity, they tend to represent a limited proportion of such portfolios. Mr Carthew notes that while 3i Infrastructure (3IN) has a more concentrated portfolio, most of the infrastructure trusts are diversified enough to withstand small setbacks. Importantly, many of them have government-backed sources of income via public-private partnerships (PPP), though the degree of exposure can vary between trusts. HICL had 72 per cent of its assets in PPP assets at the end of March (see this week's Fund Interview for more detail).

While commentators suggest that most of the generalist infrastructure trusts would pass muster as a stable income source in a portfolio, investors may feel reluctant to buy on a substantial premium to NAV. Generalist infrastructure trusts, as classified by Winterflood, traded at premiums of between 7.3 per cent (Sequoia) and 26.5 per cent (BBGI) on 14 September.

This has not hugely damaged their appeal as income plays. Even at such a high premium, BBGI’s shares offered a yield of 4.2 per cent at the time, and the other trusts tended to offer even more attractive levels of income. GCP’s shares had a net yield of 6.5 per cent, with Sequoia offering a net yield of 5.9 per cent.

The main drawback is that such premiums leave the shares vulnerable if something does go wrong. While problems could be far off, developments such as a return of equity income at its pre-Covid levels, or the emergence of better bond yields, might hurt the relative appeal of infrastructure trusts. While some may be happy to pay a premium for a solid source of income, investors would be wise to identify the trusts they favour and buy in at lower prices if they do momentarily get caught out in bouts of broader equity market volatility.

Renewable infrastructure trusts also look fairly robust, though some of their revenues do depend on where energy prices are. As we noted at the end of April (Big Theme, 1 May), names such as Greencoat UK Wind (UKW) and Bluefield Solar Income Fund (BSIF) had a notable level of exposure to market prices for energy at the time, potentially exposing their shares to greater volatility. They, and almost every other renewable infrastructure trust, traded on a double-digit premium to NAV on 14 September.

Again, specialists believe that such trusts look robust, but do warn about their current price tag and even the prospect of challenges much further down the line.

“Greencoat UK Wind’s yield is 5 per cent and it focuses on real assets with a 25-year life, and assets that are essential in the UK,” says Mr Lockyer. “I can’t see there would be a material derating from here but our concerns are the NAVs are fully valued. It hasn’t got that much further to go in terms of upward potential.”

Here, trusts that focus on newer parts of the renewables space might have better potential. Mr Lockyer, for example, would use a broader market sell-off to buy into battery storage trusts such as Gore Street Energy Storage (GSF) and Gresham House Energy Storage Fund (GRID). Their area of focus is less established than other renewable infrastructure assets and could appeal as an emerging trend.

“The yields are higher, the tech is getting better and it’s part of the infrastructure that is now becoming accepted and essential,” he says.

More generally, a new entrant in the space is Octopus Renewables Infrastructure Trust (ORIT), which listed in December 2019. Mr Carthew argues that it may stand out from its peers because of a greater onus on pan-European assets. With new trusts it can be helpful to assess the team’s expertise, track record and resources, but also accept that it can take some time for the investment manager to invest the funds raised and start to generate the target income. Some may wish to wait and see how the investment process holds up before buying shares.