- Many alternative asset investment trusts trade on big premiums to NAV so it's important to carefully scrutinise them
- Certain metrics can help to determine which valuations really are frothy
It might work well to sell beer, but 'reassuringly expensive' is not a phrase that works for many investors. Concerns about lofty valuations are common in hotter parts of the market and they apply as much to investment trusts as to shares in individual companies. Accessing popular alternative assets such as infrastructure often means buying into a trust at a hefty share price premium to net asset value (NAV).
For example, infrastructure stalwart BBGI Global Infrastructure (BBGI) recently commanded a premium of nearly 27 per cent to the value of its underlying assets. And recently launched Seraphim Space Investment Trust (SSIT) has already moved to a 20 per cent premium.
If life looks rosy enough for many alternative asset trusts right now, a premium creates the potential for prices to fall if a popular trust disappoints investors. Take the case of Civitas Social Housing (CSH), whose shares moved from a premium of around 10 per cent earlier this year to a hefty discount of around 15 per cent, recently, amid various troubles. Its shares have fallen more than 18 per cent in the six months to 25 November.
While you can get into such trusts at lower valuations via secondary fundraisings, it’s worth using certain metrics to assess whether their shares look overvalued. This is not easy but may prove useful.
The income test
As well as being topical and offering potential diversification benefits, alternative asset trusts are often highly valued because they offer high but dependable levels of income. With dividend yields moving inversely to price movements, Daniel Lockyer, senior fund manager at Hawksmoor, believes that an attractive yield can indicate a trust is not overvalued. If the yield seems insufficiently high versus those available on 'risk-free' assets such as government bonds, investors may be overpaying. As Lockyer notes, the dividend must also look supported and sustainable according to the level of dividend cover, and strength of income and cash flows.
Established generalist infrastructure trusts such as BBGI Global Infrastructure trade on big premiums. However, recent dividend yields in the sector look healthy, as the chart shows, which is also the case with many renewable energy infrastructure trusts. Of the ones with stated dividend yields, only US Solar Fund (USF), Ecofin US Renewables Infrastructure Trust (RNEW) and VH Global Sustainable Energy Opportunities (GSEO) offered less than 3 per cent at the time of writing. The latter two only came to market this year so need time to put cash to work before they can generate a substantial level income.
The data chimes with a rough consensus among analysts who spoke to Investors’ Chronicle. Kamal Warraich, investment analyst at Canaccord Genuity Wealth Management, says of infrastructure: “Physical assets are usually valued on a quarterly or semi-annual basis so there is a lag effect in the NAV value, and it is quite well known that valuations are typically conservative. Combine this with a very secure income stream that is usually inflation linked, and you have something that is very attractive.”
Mick Gilligan, head of managed portfolio services at Killik & Co, adds that many trusts in the sector trade at premiums because the market values their income generation more highly than conservative NAV calculations. “I’m not sure I would put any infrastructure funds in the ‘too high a premium’ category,” he says. But the trusts still carry risks, and renewable energy infrastructure trusts can have significant sensitivity to moves in power prices.
Lower yields are one indicator of investors paying up more for a trust. An example in the property sectors is logistics play Tritax Big Box REIT (BBOX) which had a relatively low dividend yield of 2.67 per cent on 25 November and a premium to NAV of nearly 30 per cent. This suggests that its valuation may be frothier than those of similar trusts.
GCP Student Living (DIGS) traded on a 0.47 per cent yield although this probably reflects a dividend cut enacted amid the uncertainties of the pandemic rather than a frothy valuation. Other property trusts have tended to trade on decent dividend yields, as have the music royalties trusts.
Yields are of little use as a metric for assessing investment trusts focused on capital growth. But you can look at how their shares are trading relative to peers and their own recent history.
Resources such as the Association of Investment Companies website at www.theaic.co.uk show how a trust’s premium has moved over time. You can find this on the performance tab of a trust’s page on this site. It can be useful to assess how highly valued a trust is versus the past year.
Analysts favour the more technical Z-score metric – the difference between the current premium or discount, and the average over the past year, divided by its volatility over that period. A positive Z-score shows that the share price has become more expensive versus NAV. A high Z-score can also indicate that a discount has narrowed significantly rather than the premium growing.
As an alternative measure, Gilligan suggests that investors compare a reasonable annual return expectation with the current premium on a trust and whether they match up. According to this metric and the Z-score, Impax Environmental Markets (IEM) and BH Macro (BHMG) look expensive.
The reasons behind premiums can be important in explaining how reasonable or sustainable they look. Gilligan notes, for example, that BH Macro’s recent 11 per cent premium looks “a bit toppy” versus its long-term annualised NAV return of 8.8 per cent. Yet the higher premium may reflect the trust’s ability to act as an insurance policy when equities sell off.
While Impax Environmental Markets has an enviable track record, its higher premium may relate to the recent demand for environmental, social and governance (ESG) related assets and because the trust has no plans to issue any new shares for now. Herein lies a broader risk – that fasionable trends egg on valuations. Trust Research director Simon Moore notes: “There can be a bandwagon. [This] could be an example that with ESG there’s a bit of a bubble going on.”
A specialist who wished not to be named highlighted two Ballie Gifford-managed trusts – Pacific Horizon Investment Trust (PHI) and Scottish Mortgage Investment Trust (SMT) – as looking expensive relative to their own history. Pacific Horizon has fared well amid the Chinese regulatory crackdown of the past year, continuing a streak of excellent performance.