Five specialist investment trust tips for long-term total returns

Our annual niche investment articles focus on areas best accessed through investment trusts and other closed-ended funds.

This may be because the assets in which they invest are illiquid, as in the case of ultra small companies, infrastructure/renewables, or direct property; or because they use substantial gearing, as with highly geared ordinary shares or subscription shares; or because their appeal depends on investors taking a long-term view, as with family-controlled trusts and private equity.

Alternatively they may enjoy special tax treatment, as in the case of VCTs.

Different categories will appeal to different investors, so we have divided them according to their stated objectives: income, total returns and capital returns. For most investors it is sensible to hold a range of asset classes. As always, think about your time horizons, and about how much you can afford to lose.

FAMILY TRUSTS

RIT Capital Partners

RIT Capital Partners (RCP) is our new family trust tip, despite its premium rating. We are including it because the managers are willing to pull so many different levers to achieve positive returns while protecting the share's capital value.

This reflects the priority given to capital preservation by the trust's chairman and chief shareholder, Lord Rothschild, and tunes in with the aspirations of many investors in such uncertain times.

Specialist investment trust tipsRCP invests internationally across a range of asset classes, both quoted and unquoted, and allocates sections to exceptional third-party managers to access the best external talent.

Half the portfolio is in quoted equities, a fifth in equity hedge funds, a quarter in unquoted investments, and 4 per cent in real assets such as property and gold.

In addition borrowings are used to fund exposure to absolute return and credit. North America accounts for 46 per cent of the portfolio, with 17 per cent in global, 16 per cent in the UK and 15 per cent in emerging markets, but geographical exposure is adjusted by futures and other derivatives.

Currency exposure is also separately managed, and as of end October was 64 per cent sterling and 39 per cent US dollars.

The trust's cautious approach means its NAV total returns have lagged the MSCI All Country World index over three and five years, but its resilience in more difficult times means it has outperformed over one and 10 years. The dividend has been ramped up over the last four years, but the yield remains modest.

PRIVATE EQUITY, DIRECT

HgCapital

Discounts in the private equity sector have been under pressure, as they have in many other parts of the trust market.

HgCapital (HGT) has suffered alongside the rest, and now trades at close to its highest discount in five years, although its portfolio has been making solid progress. With the dividend growing at 3 per cent a year, the yield is up to 3 per cent.

HGT focuses on mid-market buyouts in the UK and northern Europe, with the former currently accounting for 58 per cent of the portfolio.

It aims to outperform the All-Share index over the long run by focusing on the telecoms/media, services and industrials sectors, and claims its deep sector knowledge and rigorous research-based approach are 'key differentiators in the European private equity environment, which has delivered superior returns over the long term'.

Substantiating this assertion, its 10-year NAV total returns are two and a half times those of the All-Share index and the best in the private equity sector bar Electra Private Equity, which has been galvanised by predatory action.

PRIVATE EQUITY, FUND OF FUNDS

HarbourVest Global Private Equity

HarbourVest Global Private Equity (HPVE) holds its place as our private equity fund of funds partly because it offers exposure to the US economy and the dollar, and partly because it has a rigorously steady approach to investment regardless of the market environment.

At any one time it expects to be investing around 25 per cent of assets in new HarbourVest funds, to have around 50 per cent in five to 10-year-old funds that are nurturing their investments, and the balance in funds in realisation mode, which is when the main mark-ups are achieved.

By adopting this approach, it hopes to achieve exceptionally steady growth in NAV per share, avoid market-timing issues through dollar cost-averaging, and differentiate itself from its peers.

The proof of the pudding is that NAV growth has been among the best in the sector over three and five years.

HPVE's managers expect to further smooth returns through broad diversification, with exposure through HarbourVest funds to over 700 private equity funds and partnerships managed by some of the industry's leading practitioners, and via them to over 6,000 companies.

Sixty five per cent of the portfolio is invested in the US, 19 per cent in Europe, and the balance split between Asia and the rest of the world. Consumer companies and technology each account for around a third of the portfolio, industrials for 18 per cent and medical/biotechnology for 16 per cent.

HVPE has no borrowings, but its determination to keep investing steadily means it has big forward commitments. It expects to fund these from realisations, but has lined up substantial borrowing facilities just in case they are needed.

It is hoped that the trust's recent move to a full sterling-denominated quote on the London Stock Exchange will help to coax down the wide discount.

DIRECT PROPERTY

Schroder REIT

Schroder Real Estate Investment Trust made reasonable progress in 2015, including its May conversion into a more tax-efficient Reit.

Excluding the conversion costs of £400,000, earnings were more than sufficient to cover a maintained dividend of 1.24p per six months, resulting in a yield of 4.2 per cent which the managers hope to grow over time.

The trust did well to deliver NAV total returns ahead of the IPD UK property index over the year, as it is substantially underweight London and the South East, where property prices have been most buoyant, and overweight in more northerly regions.

However the managers believe prosperity is percolating around the country, and they have also been working hard to enhance returns, including selling off smaller, lower-yielding properties and investing in larger ones.

Asset management reduced the void rate from 9.2 to 8.1 per cent over the summer months, with further reductions expected following new lettings. Meanwhile, manager Duncan Owen says capital expenditure of up to £25 million on the existing portfolio could substantially enhance returns over the next year or two.

As a result, proceeds from realisations will probably be spent on such improvements, although selective acquisitions, particularly of adjoining interests, are not ruled out.

The net rental yield on the portfolio is 5.9 per cent, but the independent valuer reckons the current market rental value is around 7.1 per cent.

DIRECT LENDING

P2P Global Investment

Launched in May 2014, P2P Global Investment is the most established of the direct lending specialists. It has attracted support from Invesco Perpetual Asset Management, Neil Woodford and Axa, and has raised over £800 million, following its £400 million July 2015 C share issue.

However, its own fundraising and similar offerings by other managers have served to almost eliminate the premium on its shares. This is bad news for those who bought near the peak of 19.2 per cent, but good for new investors. Given the forecast dividend of 60p, the yield is close to 6 per cent.

P2P aims for an attractive dividend income and capital growth through investment in consumer and SME loans, corporate loans and corporate trade receivables originated mainly through online peer to peer (P2P) platforms; it can also invest in P2P platforms themselves.

It focuses mainly on the US and Europe across credit risk bands, and targets credit assets with net annualised returns of 5 to 15 per cent. It claims that by disintermediating traditional financial institutions such as banks, it allows both borrowers and lenders to achieve more attractive interest rates.

Despite mounting competition, the managers say they are being presented with 10 times more opportunities than in mid-2014, and have more than trebled arrangements with origination platforms.

The five largest are Lending Club, Prosper and Upstart (all US consumer specialists), Zopa (UK consumers) and Funding Circle (UK SMEs).

The portfolio is exposed to over 150,000 individual loans, and expects impairments of 2 to 4 per cent a year. It also holds small stakes in Prosper, Zopa and Ratesetter.

P2PGI has recorded positive NAV total returns every month since launch.

However, it warns that 'the market in which the company participates is competitive and rapidly changing', that the regulatory environment is unpredictable - with some US states now off limits - and that it could be substantially affected by changes to factors such as inflation and interest rates.

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