- Many alternatives sectors have boomed this year
- Fund selectors still see value across the board, but investors should do their research
As we wrote about extensively in our investment trust special in November (IC, 12 November), 2021 has been the year in which alternatives have boomed with record sums being raised for closed-ended vehicles. For the year to 2 December, infrastructure trusts raised a total of £5.36bn across initial public offerings and secondary raisings, while private equity sectors raised £2.1bn, according to the Association of Investment Companies.
This popularity has led to some cautiousness on the sectors involved. As Mick Gilligan, head of managed portfolio services at Killik & Co put it, “quite often, the longer we are into an IPO cycle, the lower the quality of the offering becomes”. That said, experts predict that alternatives will play an increasingly important role in investor portfolios as ultra-loose monetary policy has, generally, increased the correlation between equities and bonds. This is because the more valuations are driven by earnings in the distant future, the more sensitive they become to interest rate changes, with both bond prices and highly valued stocks more likely to fall when rates rise.
An interesting and new area that has gained traction in recent years is music royalty trusts. There are currently two: Hipgnosis Songs Fund (SONG), which launched in 2018, and Round Hill Music Royalty Fund (RHM), which launched in November 2020. The premise of these funds is to deliver a regular and growing income by buying music catalogues from record labels and cashing in on the income generated from the royalties.
Investors have been attracted to these offerings because, while both are reasonably new with limited track records, they are deemed to have a low correlation with traditional equities and bonds, benefit from strong growth in music streaming and are currently valued on a relatively conservative basis (meaning high discount rates are used).
Hipgnosis is the much larger of the two with a market cap of £1.55bn on 3 December and a yield of 4.1 per cent. But it traded on a premium to assets of 8 per cent as of that date, unlike Round Hill Music which traded closer to net asset value (NAV). Round Hill is yet to publish its first full-year results.
“Free cash flow is a good indicator of the cash position of these investment companies and their ability to fund dividend payments,” Gilligan says. The Hipgnosis dividend is 1.6 times covered by cash flow. This is much higher than the typical infrastructure fund. However, it seems too early to say with any confidence that the net asset values and income streams on these trusts will prove resilient.
Over in private equity, trusts have had a very good year, boosted by a narrowing of discounts. Winterflood’s private equity funds of funds sector had average share price growth of 45 per cent for the 12 months to 3 December, while private equity funds investing directly generated average share price growth of 36 per cent.
Gilligan says he thinks there are certain points in the cycle when listed private equity trusts look more attractive. “This is typically early cycle, when quoted equities are seeing a strong recovery but private equity has not yet caught up and big discounts are available. I think current conditions are more indicative of mid-cycle rather than early cycle.” Overall, he says he’d prefer to focus on quoted equities, with lower fees and greater transparency. The average ongoing charge in private equity is 2.7 per cent annualised.
“From a portfolio perspective, private equity should be seen as a higher-risk investment and therefore is probably more suited to those investors who can tolerate this risk,” says Ryan Hughes, head of investment research at AJ Bell. He suggests an allocation of up to 10 per cent might be appropriate and recommends BMO Private Equity Investment Trust (BPET) for diversified exposure to the sector.
Infrastructure trusts, meanwhile, remain a fast-evolving area, particularly with regard to renewable energy. Analysts have warned that those trading on double-digit premiums could be vulnerable to a sudden change in sentiment if investment conditions shift, but the income paid out by these vehicles has been resilient.
Ben Yearsley, investment director at Shore Financial Planning, says that funds that own real assets, such as infrastructure trusts, should typically prove beneficial in an inflationary world. “If you were investing for the next decade I would tuck the new Foresight Sustainable Forestry Trust (FSF) away – mix of existing forests mainly for timber and new forests that benefit from carbon credits,” he says. For those with a shorter-term outlook, he recommends looking at Digital 9 Infrastructure (DGI9), which invests in private assets that help power the internet.
