The investment trust income story does not end with stocks and bonds

It is testament to the flexibility of investment trusts that they can offer exposure to such a diverse collection of potential investments. Beyond the standard form of listed companies they offer more niche interests which span from private equity to wind farms and even loans to shipping companies.

All of this means investors can access income from a variety of different sources beyond traditional asset classes like stocks and bonds, plus generating returns that are often uncorrelated to the financial markets.

A BETTER FIT

The closed-ended structure of investment trusts makes them a better fit with less liquid assets such as property and other ‘alternative’ assets.

Many of the investment trusts which invest in alternative assets, often alongside equities, sit in the Association of Investment Companies’ (AIC) Flexible Investment sector which is largely made up of multi-asset funds.

The table shows the higher yielding names in this grouping with assets of £50m or more.

Tetragon Financial (TFG) invests in a mixture of bank loans, real estate, equities, credit, convertible bonds, private equity, infrastructure and TFG Asset Management, a diversified alternative asset management business.

It is possibly too complex for some investors and this is reflected in a more than 42% discount to net asset value (NAV). This discount may also reflect the difficulty of valuing the underlying assets in the portfolio. Despite these issues, broker Stifel points out that Tetragon has consistently grown its dividend since 2009.

The £475m asset Aberdeen Diversified Income & Growth (ADIG) was launched in its current format in February 2017 through the merger of BlackRock Income Strategies Trusts and Aberdeen UK Tracker. It has a wider remit than traditional multi-asset funds, investing in areas like farmland and trade finance. At 119.5p it trades at a 0.6% discount to net asset value, and investors can expect a dividend yield in the region of 4.4%.

THE INFRASTRUCTURE SPACE

Some trusts focus on specific types of alternative asset, perhaps most notably infrastructure.

Infrastructure as an investment theme has become increasingly popular in recent years. It is relatively uncorrelated to the equity market and can provide a predictable stream of income, often rising ahead of inflation, over the long term.

The £1.45bn takeover of John Laing Infrastructure earlier this year by a consortium of funds helped revive sentiment towards the infrastructure space which had previously suffered as the idea of private money being invested in public projects becoming more politically unpopular.

Among the investment trusts with exposure to the infrastructure space is HICL Infrastructure (HICL) which trades at a 6% premium to NAV and offers a dividend yield of 5.2% according to data from the AIC.

Other constituents of this investment trust sub-set include International Public Partnerships (INPP) and GCP        Infrastructure (GCP).

WHY OPEN-ENDED FUNDS AREN’T SUITABLE FOR ILLIQUID ASSETS

You may wonder why illiquid assets such as infrastructure projects are dominated in the closed-end space (i.e. investment trusts) rather than opened-funds (unit trusts and Oeics). The reasons why are fairly straightforward.

Investors are entitled to redeem their interest in traditional open-ended funds at net asset value, and if a large number of investors want to sell their interest in a fund at the same time the company might have to sell assets to meet these redemptions. (i.e. raise cash to pay money back to the investors).

In contrast, investment trusts – also known as investment companies – have a fixed number of shares and can trade at either a discount or premium to their net asset value based on market sentiment.

When someone wants to sell their interest in an investment trust, they are simply selling their shares to someone else in the market. The fund manager doesn’t have to do anything to the portfolio because of the buying and selling of shares between investors.

‘Structural advantages of investment companies include the ability to focus on actively managing underlying portfolios without the distractions of inflows/redemptions, which are often sentiment driven and at the wrong time in the cycle,’ says investment bank Canaccord Genuity.

In addition, open-ended funds can struggle to sell illiquid assets fast enough to meet redemptions – notably this was the case for several UK property funds in the wake of the Brexit vote in June 2016 and they had to suspend trading as a result.

The Financial Conduct Authority recently published a series of proposals which would force open-ended funds investing in illiquid assets to suspend trading in certain circumstances and for the products to be badged as having high liquidity risk. (TS)

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