InvestmentsMar 7 2016

Unusual asset classes dominating launches

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Unusual asset classes dominating launches

The continued search for income and investments that are uncorrelated to traditional equities and bonds is pushing more investors towards alternative asset classes.

Property, for example, was a consistent favourite for investors in 2015 in both open-ended and closed-ended vehicles, with the Association of Investment Companies (AIC) Property Direct UK and Infrastructure sectors the third and fourth most popular for adviser purchases in the third quarter.

But with low interest rates looking set to continue and global growth appearing anaemic at best, there is a small but growing trend to more unusual and potentially more illiquid asset classes appearing in the investment trust world.

Popularity of alternatives

Annabel Brodie-Smith, AIC communications director, notes:

“Interestingly, alternative assets are popular with advisers, with Property Direct UK, Infrastructure and Debt being advisers’ third, fourth and sixth most popular sectors within the investment company industry. The Infrastructure sector is the most highly rated sector overall on an 11 per cent premium in comparison with the average investment company, which is on a 7 per cent discount.”

From aircraft leasing to peer-to-peer lending, to the recent launch of the HealthCare Royalty Trust, the range of products available is growing, with 18 trust launches in 2015 investing in what could be considered alternative asset classes.

Annabel Brodie-Smith, communications director at the AIC, explains: “Yield-generating alternative assets are continuing to dominate launch activity within the investment company industry. The two most popular alternative assets when it came to launches last year were the Debt sector, where six firms were launched, and Property, with four companies launching – two investing in the UK and two in Europe.

“The search for income led to a number of more unusual investment companies, including [those] investing in aircraft leasing and diversified equipment leasing. However, the industry has always had a number of these types of firms investing in unusual assets and this is part of a long-term trend.”

One of the reasons for this trend is the structure of trusts as a fixed number of shares and the ability to engage in gearing make them suitable for many types of illiquid and alternative assets.

James Burns, head of the multi-manager team at Smith & Williamson, notes one of the most interesting areas is aircraft leasing, where listed vehicles include Doric Nimrod Air Three and newer offerings such as Amedeo Air Four Plus. These firms buy and lease commercial aircraft.

He notes Doric Nimrod Air Three raised funds using a combination of debt and equity to buy four Airbus A380 aircraft, which were then leased to Emirates airline for 12 years. Equity investors benefited from an 8.25 per cent dividend yield, with no foreign exchange risk – the only risk to the dividend is that of the airline collapsing and being no longer able to lease the aircraft.

Mr Burns explains: “At the end of the 12-year lease period, investors’ initial capital [£1 per share] is returned to them as long as the aircraft can be sold on for about 40 per cent of their initial value. If they are sold for more than that, investors benefit from capital growth as well as the income they have received.

“Overall, dividend yields in aircraft leasing are attractive and total returns have been stronger than those offered by the broader equity markets. It is extremely unlikely that investors would be able to find an 8.25 per cent yield in credit markets without taking significant credit risk, and the aircraft leasing vehicles are backed by the physical planes, which will always be worth something,” he adds.

An alternative investment – HealthCare Royalty Trust

Clarke Futch, investment manager of the Healthcare Royalty Trust and co-founder of HealthCare Royalty Partners, explains the attraction of a niche asset class:

“Royalty financing is an alternative means by which healthcare companies can raise non-dilutive capital or a way for universities or inventors to capitalise on their research and development work. A royalty investor typically provides upfront capital in exchange for a percentage of the future revenues or cashflows from the sales of the relevant healthcare products.

“In 2015, the royalty monetisation market experienced its second strongest year on record with more than $5.5bn (£4bn) in transactions. Despite rapid growth, royalty investing remains only a small fraction of all biopharmaceutical capital raising. From 2009 through 2014, it is estimated royalty investments represented less than 3 per cent of total capital markets activity, demonstrating the relative immaturity of royalty investing and the potential for further significant growth.

“Healthcare royalties are an attractive asset class because of their ability to deliver yield in the form of regular quarterly cashflows, which are largely non-correlated to the broader equity and bond markets.

“Royalties are derived from pharmaceutical sales, which surpassed $1trn in 2014, and have proven to be resilient during periods of economic and market uncertainty. This non-correlation was particularly evident during the global financial crisis as pharmaceutical sales continued their steady growth despite record volatility across the broader equity and credit markets.”

Meanwhile, Fidelity associate director of investment trusts Alex Denny points out that trusts have a long history of change, “and it is times like this when adaptability must really be shown by the sector”.

He explains: “We are now seven years into a market cycle in which many trusts have enjoyed something of a renaissance. New issuance has been strong and discounts have been narrowing year on year, with premiums persistent in many income-paying sectors.

“There are many reasons for optimism among managers. Investment trusts are able to access asset classes not open to traditional Ucits funds – such as real estate, infrastructure, debt or alternatives, all providing valuable diversification from equities in both income and growth areas. The list of ‘sector specialist’ trusts seems to grow longer with weird and wonderful options for diversification.”

Mr Burns also highlights vehicles specialising in peer-to-peer lending, as well as areas such as student property and even litigation alongside the more traditional private equity alternatives.

“The growth of these areas is being driven by the search for income, but also because the mainstream banks are no longer willing or able to meet the financing needs in these specialist areas – [hence] investment firms have stepped in to fill the gap. It is hard to launch a conventional equity-based trust nowadays, but demand for those investing in alternative assets is very healthy,” he adds.

Nyree Stewart is features editor at Investment Adviser