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Co-investor risk resurfaces for nervy allocators; DFMs unconvinced by equity income reserves

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Accidental bedfellows

What do you get if you cross quarter-end positioning with a big margin call? The answer, seemingly, is the Archegos drama that's played out over the past few days. With some brokers and share prices nursing big losses, investors’ attention has briefly turned away from the reinflation trend.

The catalyst for these moves, it’s now clear, was a single family office. Yet while the drama has caused ruptures on Wall Street, the fallout for UK-based wealth managers has been confined to a few percentage points off Chinese equity fund positions (for those that hold them). That’s nothing out of the ordinary.

Investors of all stripes still await signs of other possible spillover effects. As it stands, the medium-term impact for markets as a whole appears to be confined to bank share prices – in particular those most on the hook for Archegos losses.

But fund managers will also be giving renewed thought to the fact that positions of this size can be levered up without the holders in question ever appearing near the top of shareholder registers.

And there have been signs that fellow investors are growing more wary of those that do disclose their positions. The market rotation has meant co-investor risk is moving back up the agenda for those who invest alongside the very biggest strategies.

Financial News reported last week that at least one “London fund manager” has pulled out of positions that are also owned by Ark ETFs, for fear of the impact if those giant tech-focused US funds were forced to sell positions to meet redemptions. An economic recovery may be underway, and markets are still on the up,  but worries about fellow investors - which amount to liquidity risks in all but name -  remain paramount for many allocators.

Unreserved

The publication of the first-ever investment trust dividend monitor has underlined closed-ended vehicles’ resilience last year.

Last spring there were warnings that even trust reserves might not be enough to combat the swathe of payout cuts expected in 2020. With hindsight, the majority of equity-focused trusts were able to stand firm. Analysis from Link shows only a quarter of UK equity income trusts have cut payouts since last April. Year-on-year, the average UK equity trust payout rose by 3.8 per cent. For global trusts, this figure rises to 9.3 per cent.  

Some may consider this a temporary mercy: after all, not all company payouts are going to rebound immediately. But trusts still have a fair whack in reserve, according to Link's calculations. Of the £1.6bn in revenue reserves that investment trusts of all stripes had available to them as of Q2 2020, a rough estimate suggests £900m is still intact. That gives them room for manoeuvre yet.

This resilience hasn’t translated into a surge in interest from professional fund selectors; our fund selection database gives little indication of DFMs buying into equity-focused income trusts last year. Their selections, on this front, remain as few and far between as they have ever been. Revenue reserves or no, as far as fund buyers are concerned it’s still only in the alternative income universe that trusts have the edge over open-ended peers.

Drying up

The news that 7IM has suspended two funds due to illiquid holdings combines aspects of both the above stories. The former Turcan Connell strategies each have sizeable positions in the suspended Xenfin Securitised Debt fund, but a more recent development involving a smaller position may have proven just as consequential.

The firm isn’t confirming the names of the two holdings it says have prompted the suspension, but of its other positions, a stake in the Drum Income Plus Reit looks to be the most likely candidate. The board of the Reit, which like so many offers investors a chunky yield, said earlier this month it was considering winding up the strategy in view of its lack of liquidity. It added a strategic review of options might take “a few months”.

7IM, for its part, said in its suspension letter that “both [illiquid] assets have experienced events in recent weeks…which have caused uncertainty over the timings of a reduction in these position weightings”. Each fund has around five per cent of assets in the Reit, in addition to twice that in the Xenfin strategy. That combination ultimately proved unsustainable.

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