How multi-asset funds use investment trusts

What makes my job at FundCalibre so interesting is that we meet many different fund managers who run all sorts of different products. Even after 20 odd years in the industry I rarely leave a meeting without having learned something new. And that’s exactly what happened when I interviewed Dr Niall O’Connor recently.

As manager of the SVS Brooks Macdonald Defensive Capital fund, Niall’s job is to invest in ‘other’ assets – avoiding your bog-standard equities and bonds and finding opportunities in other areas.

One such area at the moment is investment trusts. “Investment Trusts comprise up to 50% of the fund’s assets,’ he said. “These investment trusts are not traditional equity investment trusts but ‘alternatives’ since they provide exposure to a broad range of asset classes that can range from private equity, infrastructure, and renewables to shipping or music rights.”

Niall went on to explain that investment trusts – in particular REITs – have had a tough start to the year. But his belief is that the price moves were driven by flows more than fundamentals: investors have been flocking to the perceived safety of bonds as yields have risen, and redemptions at open- ended funds that are traditional holders of investment trusts have also put downward pressure on pricing.

“We see this impact through ever-widening discounts to Net Asset Values (NAV),” he said. “We liken these magnitudes of discounts to holding a balloon underwater. They can persist, they could even widen further, but ultimately when released the rally in share price can be dramatic.

Niall says there are two mechanisms for release. “The first is ‘continuation votes’ built into the articles of most investment trusts. These allow (usually 5-yearly) shareholder votes on a managed wind-up of the vehicle. In recent years with lowish discounts there has been no point activating them, but with the currently very high discounts it now makes sense from a purely economic view to vote for a wind-up. Recently investment trusts such as US Solar, Aquila Energy Efficiency, Starwood European Property and NBMI (see below) have all begun this process.”

The second is from a merger or an acquisition. “Any investment trust on a larger than c-25% discount could be bid for at a 30% premium and still be accretive to the acquirer,” he said. “The discounts on investment trusts are (like most market measures) a balance of supply and demand. Both were plentiful up to 2021 with lots of buyers and many Initial Public Offerings and secondaries. Demand, perhaps unsurprisingly, ceased for most of 2022 widening discounts. 2023 is the year where supply will turn negative though buybacks, wind-ups and possibly M&A. Investment trusts with extremely wide discounts look attractive to us now.”

This led me to wonder how other multi-asset managers use investment trusts in their portfolio and where they are finding opportunities. Here’s what a selection of Elite Rated managers had to say:

Richard Parfect, manager, VT Momentum Diversified Income

“Investment trusts can be seen as specialist, but with experience and expertise you can use them to diversify risk and returns.

“Certain assets of economic and social infrastructure can display low or even zero correlation to economic activity if revenues are earned by simply being available. One example is Offshore Transmission Owner assets (OFTOs) within International Public Partnerships (an infrastructure trust), who are paid to transmit power from offshore wind farms regardless of the power price, or even if there is any wind.

“Returns are not risk free of course. Underlying assets may be prone to regulatory and political risks; and valuation risk is always present, not least when the benchmark return that the assets are priced off is the yield of government debt. The key thing in the space is to be cognisant of these factors.

“Efficient risk adjusted returns are achieved by a long-term strategic asset allocation to the space. Tactical navigation too can bring added opportunity through both share price discount or premium to NAV that can be displayed at times. Ultimately, short-term volatility is the opportunity to add long term value.”

Vincent McEntegart, manager, Aegon Diversified Monthly Income

“As active investors we believe in the merits of both dynamic asset allocation and individual security selection, rather than a fund of funds approach, when constructing bespoke portfolios.  There are, however, times when we find closed-end funds offer an attractive vehicle for accessing otherwise unavailable investment opportunities, particularly in the alternatives space.

“The Aegon Diversified Monthly Income fund cannot directly own off-market investments or assets such as windfarms, toll roads, direct property and so forth but we can access their attractive, contractual (often inflation-linked) cashflows through listed funds.

“The opportunity set waxes and wanes as the market and the macro environment evolves. When rates were low, the certainty of their long term cash flows merited a premium valuation; they acted as bond-proxies. But as rates rose through 2022, this became less valuable. Higher bond yields increased the relative attractiveness of that asset class and diminished the value of bond-proxies. Rising discount rates reduced the present value of future cashflows for some of the infrastructure funds for example.

“Similarly, a backdrop of rising interest rates and higher funding costs made Real Estate Investment Trusts an unattractive option. Our largest allocation shifts during 2022 were to reduce exposure to these investment funds in favour of real bonds. Our allocation is at historic lows, but a Central Bank pivot might help change the outlook.”

Vincent Ropers, co-manager, TB Wise Multi-Asset Growth

“Investment trusts are the cornerstone of our fund, historically representing 60-80% of the portfolio. As multi-asset investors, the main attraction of investment trusts is that they offer a genuine breadth of exposure to non-traditional asset classes such as private equity, infrastructure, renewables, debt or property. This allows us to create a diversified fund of funds which, historically, has kept up with equity returns but with less volatility.

“With a fixed pool of capital rather than having shares created or cancelled based on demand like in a traditional mutual fund, liquidity is also aligned between investment trusts and their underlying assets. This makes it the perfect structure to invest in less liquid parts of the market, not only in alternative assets like the ones highlighted above but also in traditional assets such as smaller equities or longer-term activist strategies. Those present great potential for above average returns but are hard to manage in the traditional mutual fund structure.

“As appealing as they are, however, investment trusts can require specialist skills when it comes to trading, due diligence, corporate actions, discount management, etc…Our aim is to provide that expertise in a fully packaged fund, offering access to this attractive niche part of the market without the hassle for investors.”

Rob Burdett, manager, CT MM Navigator Distribution

“We do use listed investment companies (also known as investment trusts) in the CT MM Navigator Distribution fund portfolio.  Typically this is when the underlying assets have a low liquidity meaning they are suited to the closed capital structure.  Further conditions for the inclusion of investment trusts would include a favourable outlook for the various ‘moving parts’ an investment company can offer such as a discount to NAV or gearing.

“The type of assets that feature in our portfolio exposure to investment trusts currently is limited to less economically sensitive areas such as music royalties, supermarket freeholds, aircraft leasing, infrastructure lending and asset backed debt.  This means we are absent from some of the biggest segments of the investment company market such as property, private equity and renewable energy.  This is partly due to high ratings in recent memory, and in some cases too high a correlation to equity markets.

“Our current weighting towards investment companies is close to a low for the fund’s 15-year plus history, but this may change in the future, as much of the sector is now on a discount to NAV.”

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