How to measure the success of alternative asset investment trusts

With investors looking beyond traditional markets for returns, the alternative assets fan club continues to grow. Investment trusts that invest in assets other than public equity and bond markets have dominated recent fundraising activity. The three trust sectors that accounted for the largest volumes of secondary fundraisings in the first half of 2021 focus on infrastructure and unlisted companies, and investment trust initial public offerings (IPOs) in recent years have been dominated by non-equity vehicles.

And these asset classes continue to grow and mature. Property and infrastructure sectors have broadened out in recent years with launches of trusts that focus on sub-sectors, from battery storage funds in the renewables space to Home REIT (HOME) which invests in accommodation for the homelessness. A greater number of trusts now invest in unlisted companies with, for example, a newer asset class becoming available to private investors via the launch of two music royalties trusts.

Such assets appeal for reasons including impressive levels of income and less reliance on the health of stock markets and economies. Private equity, capital growth and other trusts with a focus on unlisted companies provide access to companies at a stage of potential rapid growth before they list on public markets.

But monitoring such trusts' progress can be frustratingly difficult. Unlike equity funds, alternative asset trusts lack an obvious performance benchmark for investors to reference. 

An elusive measure of success

As Brooks Macdonald chief investment officer Edward Park notes, the uncertainties around alternatives are rife. “In many of the newer sectors there are no clear fund comparables or, if there are, their track record is still relatively short,” he says.

Because alternative asset classes are mostly available to private investors via closed-ended funds they also need to consider whether to focus more on the funds' share price or net asset value (NAV) performance. Park adds that other complications arise when there is “no easily accessible market price” for esoteric assets, forcing trusts to calculate NAV using models or estimates. NAV updates can also be subject to lengthy delays which creates uncertainty, particularly in the private equity sector.

This can make due diligence seem particularly daunting, but certain rules of thumb apply. As with any holdings, consider whether an investment trust is fulfilling its specific role in your portfolio. Also look at how portfolios perform in different market conditions, whether they are meeting their own targets and how they compare with peers and other relevant assets. The uncertainty around such assets can justify a level of caution, such as diversifying across alternative assets, limiting position sizes or waiting for an asset class to mature before investing.

Income prospects

From generalist and renewable energy infrastructure to property, music royalties and even some private equity vehicles, alternative assets have stood out as a good source of income at a time when bond yields remain depressed. Even if you hold such funds for their total returns or as diversifiers, it is likely that much of their return comes from income.

While many of these trusts tend to trade on juicy dividend yields, it is worth monitoring the durability of their dividends and the fundamentals behind them. You may take an interest in whether the dividend is maintained and raised, but the fundamentals also matter. For example, in the property space, rent collection has been an important metric amid the lockdowns of the past year or so. In generalist infrastructure portfolios it is worth assessing the extent to which the income is linked to secure, long-term contracts rather than more economically sensitive assets, such as toll roads. And some renewable energy infrastructure trusts can be vulnerable to moves in power prices, something worth checking in their financial reports.

Peer group comparisons can also be useful, but make sure that you compare like with like. Property and renewable energy infrastructure sectors include sub-sectors where there are very few trusts. For example, there are just two dedicated battery storage funds and only two property companies have an explicit focus on care homes.

Broader comparisons can be more useful in bigger sectors, such as the Association of Investment Companies (AIC) Property – UK Commercial sector. But bigger sectors can house trusts that follow different processes and take different levels of risk. Commercial property trusts have notably different strategies and sector allocations to each other, while the AIC Private Equity sector contains funds with vastly different levels of diversification. Similarly, different areas of the renewable energy infrastructure space can vary by risk and potential return. So it's most worthwhile comparing funds that focus on similar sub-sectors and regions.

Share price versus NAV

It is important to monitor NAV performance as it gives a sense of how a trust's assets hold up in unusual circumstances. The delayed NAV updates on private equity trusts have tended to show a high level of resilience amid the volatility of the pandemic. But as NAV updates on many alternatives can be sporadic, a share price can sometimes be more instructive about how investors view an asset class. Private equity trust shares have surged despite delays on NAV updates, reflecting the resilience of their portfolios, while some renewable energy infrastructure trust shares have struggled, possibly reflecting concerns about future power prices.

"As a general rule of thumb, we prefer to focus on the market price of an alternative investment trust rather than just the net asset value," Park notes. "NAVs may only be updated periodically, can be based on estimates and give an impression of an overly smooth path for investors. By contrast, the share price reflects the liquidity of the investment an investor holds as well as the real life pricing, should they wish to increase or decrease their holding."

More generally, a level of caution is warranted in new and niche sectors. As we noted earlier this year (IC, 15 January 2021), Hipgnosis Songs Fund (SONG) has been criticised about the way in which its assets were valued. Although Hipgnosis has since made some changes and the music royalties sector has broadened out slightly with the launch of Round Hill Music Royalty Fund (RHM), comparing the two would be a specialist endeavour. As Rob Morgan, chief analyst at Charles Stanley, puts it: "How do you judge a music catalogue against another? Each artist is different, so it is a bit like stockpicking in that sense but track records are still short so there's little to go on."

Similar concerns apply to esoteric areas such as aircraft leasing. Although these funds have performance targets, you need to think carefully about their assets' risks and business models, and the knowledge and experience of their managers. As Morgan adds, this can be "closer to assessing an individual company than a fund".