Gaining exposure to alternative asset classes

Specialist investments are accessible, and they are no longer the preserve of sophisticated investors

INVESTING into sectors like infrastructure, structured debt and private equity may seem complicated, but there are straightforward vehicles that allow you to gain exposure to them. And in some cases, they could actually improve your portfolio’s risk profile.

These alternative investments are no longer the preserve of sophisticated investors. They can be easily accessed through investment companies or trusts. These are closed-end investment vehicles that issue a fixed amount of shares and are traded on a stock exchange.

And because they are listed entities, they can be bought through a share dealing account or broker, where they will be subject to brokerage fees of around £10 to £15 per transaction, as well as annual management fees. They can also be held within an Isa or a self-invested personal pension (Sipp), allowing you to shelter gains from tax as long as the fund is listed in the UK.

Investment companies can trade at a discount, allowing investors to buy funds below their net asset value (NAV). According to Winterflood Securities, the average discount for investment companies stands at 7.4 per cent. But as funds become more popular, they can trade at a premium too.

STRONG DEMAND

Demand for closed-end vehicles has been strong recently. Over £1.4bn has been raised by investment companies in the first quarter of 2013, compared to £1bn in the first quarter of 2012.

Their popularity seems justified. In the first quarter of 2013, the FTSE Equity Investment Instrument index was up by 11.1 per cent, compared to a rise of 10.3 per cent for the FTSE All Share index. This was the third consecutive quarter of outperformance.

And 80 per cent of cash raised this year has been allocated to companies investing in alternative asset classes (like infrastructure and debt). Charles Cade of Numis Securities argues that investment companies are more suited to investing in specialist sectors since open-end funds can be subject to volatile inflows and outflows, which can disrupt a fund’s strategy.

This disruption has the potential to trap investors. For example, during the financial crisis, many open-end property funds had to gate investors to stop them redeeming their money. However, the close-end nature of investment companies tends to avoid this problem.

SEARCH FOR INCOME

Cade attributes part of the recent strong demand for investment companies to investors’ search for income. Investment companies have greater flexibility in terms of retaining income than their open-end alternatives. This has allowed many – like City of London Group and Alliance Trust – to build a strong track record of dividend growth, providing investors with a greater degree of income certainty.

Infrastructure investments are also useful for income, and they have been popular recently as the government tries to encourage investment into the sector. The closed-end approach is beneficial since these sorts of investments require certainty about the amounts of capital that funds must commit. But for investors, they also allow liquid exposure to often illiquid asset classes.

GCP Infrastructure, for example, invests into infrastructure debt. “The fund’s 6.7 per cent yield is attractive in the current low interest rate environment, and compares favourably against its peers,” says Simon Elliott of Winterflood Securities.

When GCP Infrastructure was launched, the fund targeted a yield of 8 per cent, but strong demand has driven it down. The fund trades at a premium to its net asset value of 10.7 per cent, compared to a sector average below 2 per cent.

While this is a good reflection on the fund, Cade says that it presents some risks. “As demand levels change, premiums could fall to sector averages.” It is, therefore, wise to be cautious about placing too much emphasis on premiums and discounts, and instead focus on the fundamentals.

BANKING ON GROWTH

For investors targeting growth, private equity companies are an attractive option. Over the last year, shares in private equity companies like 3i Group and SVG Capital are up by 50 per cent and 39 per cent respectively. But most funds have outperformed the sector, and this has led to a narrowing of the discounts to NAV.

At the start of the year, the average discount for private equity companies was 24 per cent, whereas it is now 11 per cent. “The listed private equity sector can no longer be described as a value play following its recent run,” says Elliott. It means that investors need to be selective about the type of companies – and the strategies – that they choose to invest into.

But Alex Barr, co-manager of the Aberdeen Private Equity Fund thinks that the sector will continue to shine, as listed companies remain vulnerable to the stock market volatility, while private equity companies are shielded since they invest into unlisted entities. He also thinks that the remuneration of private equities managers incentivises success: “Managers are more incentivised to deliver returns as lower base salaries, and innovative performance-linked bonuses, can dictate an individual’s total compensation.”

Barr’s fund is a fund of funds that invests in venture capital, growth companies and buyout strategies, offering investors diversified exposure to the sector. The fund’s shares have grown by over 60 per cent over the last year, while the NAV has only grown by 8 per cent, implying strong demand.

However, Cade cautions that private equity can be prone to high gearing levels, making it vulnerable to a tightening credit conditions. “If you went through another credit crisis, it would be a huge problem for the private equity industry.”

NOT JUST FOR THE SOPHISTICATED

Many would assume that investment companies are only suited to sophisticated investors. But Cade disagrees, citing debt funds as an example. “These funds often have a lower risk profile, since they are linked to Libor, rather than fixed rates. If rates rose, investors would have a degree of protection, which they wouldn’t with corporate bonds funds, for example.”

However, the niche nature of alternative investments means that it is worth seeking advice to ensure that you are making investment decisions that are in line with your portfolios long-term objectives. Websites such as FindAWealthManager.com can help you to find an appropriate adviser.

And since there are numerous funds available, it is also important to understand what a fund tries to achieve. Research websites like Morningstar can help here.

However, you should be careful about comparing specialist funds with general benchmarks, since even funds listed in the same sector may have different investment strategies. Instead, it may mean more to compare them with their peers.

Share

In Other News

April 16, 2014, 7:50am
April 16, 2014, 2:07am
April 16, 2014, 1:57am
April 15, 2014, 1:14pm