Investment trust buyers should be wary of signs that the search for yield is entering a “more discerning phase” in 2016, Alan Brierley from Canaccord Genuity has suggested.
A majority of trusts investing in alternative types of debt – typically marketed as alternatives to traditional fixed income funds – are failing to meet their return targets, according to the wealth management firm’s director of investment research. This should spark a debate about whether dwindling returns represent more than just a blip, he said.
“The loss of momentum in some alternative income strategies over the past 12-18 months raises the question of whether this is just a temporary mid-(extended) cycle slowdown or symptomatic of the credit cycle moving into a more mature stage,” Mr Brierley explained.
He also questioned the notion that loan-based products in particular have capital preservation qualities that would help them withstand the latter stages of a cycle.
“We worry about what happens when (not if) we reach the latter stages of the cycle. In this scenario, we see material downside,” Mr Brierley wrote in a note on the JPMorgan Senior Secured Loan fund.
While acknowledging that the managers of this trust maintain the credit cycle is in a “late mid-cycle phase”, the analyst added that his concerns are not limited to a single vehicle.
Writing about the NB Global Floating Rate Income trust last October, he pointed to the potential impact of a period of market stress on both loan prices and trust discounts: “In a real risk-off market, we fear that the rush for the exit in both cases could be a very crowded and painful one.”
The variety of income-generating investment trusts on offer has prompted significant interest in recent years as ultra-low interest rates bolster the attraction of yield.
Mr Brierley acknowledged that there is little sign of this underlying motivation dissipating, particularly as the expected date of a hike in the UK’s base rate of interest has been pushed back again.
Last week alone saw two investment banks – Goldman Sachs and Bank of America Merrill Lynch – revise their forecasts for a UK rate hike. Both scrapped their predictions of a second quarter hike in favour of a Q4 move.
The desire for income will remain “well entrenched” as a result of this prolonged low-rate environment, according to Mr Brierley. But he also emphasised other headwinds for income this year, not least the challenges facing UK equity income at a time when corporate dividend cover has fallen and commodity-related sectors are under intense pressure.
He added: “We are mindful that many years of strong returns have impacted underlying valuations of many asset classes.”
THE SEARCH FOR INCOME
Q4 2016
Both Goldman and BofA ML believe UK rates won’t rise until the fourth quarter
6.6%
The average yield of new trust issues in 2015
