Investment trust tips for trickier times

In challenging markets, these specialist trusts provide resilience and add diversification.

It was a difficult year for global stockmarkets, so it was good to see the majority of our annual niche investment company selections achieving positive share price total returns, in some cases despite flagging ratings.

Our niche selections should be seen as complementary to the predominantly equity-focused conservative and adventurous investment trust selections, which we update every quarter (see this article for the latest tips update). They are likely to underperform the equity-oriented selections when markets are rising, but they will hopefully continue to prove relatively resilient in difficult times.

A number of them focus on areas such as property, unquoted companies and infrastructure concessions, which are so illiquid that they are far better suited to closed- than open-ended funds. Family-controlled trusts derive their appeal from their boards' commitment to an exceptionally long-term approach, while venture capital trusts are interesting because of the special tax treatment they benefit from.

Investors often have priorities that are highly individual to them. Youthful contributors to a pension, for example, are likely to favour long-term capital-only returns, whereas retirees are likely be more interested in income than capital growth. We have therefore categorised our selections according to their investment objectives.

Long-term total returns

Family trusts: The attraction of family-controlled trusts is their multi-generational approach, which typically involves investing for the long term, guarding against downside risks, controlling costs and targeting a progressive dividend to keep the wider family happy. Caledonia Investments (LSE:CLDN), which is 35% owned by the Cayzer family, ticks all these boxes.

With Cayzer scion and lead shareholder Will Wyatt in charge, the trust has been meeting its strategic aims, which are to deliver returns of retail price index inflation plus 3-5% over the medium term, outperform the FTSE All-Share index over 10 years, pay an increasing annual dividend (as it has done for the past 51 years) and manage risk to avoid permanent loss of capital. Despite this, its shares trade on a discount of 20%.

The discount can be partly attributed to the Cayzers' large stake, which inhibits share buybacks, and partly to the trust's sizeable exposure to private equity, which tends to trade at a wider discount than quoted equities do. However, Caledonia has being doing well from its patient and supportive approach to unquoted stocks, and in theory they could hold up relatively well in a bear market. 

Caledonia's 36% exposure to the UK is higher than most global trusts and could provide a useful uplift when Brexit is finally sorted. Wyatt puts a lot of emphasis on investing in companies with significant market positions and strong balance sheets, and has been cautious of valuations for some time. He looks well placed to steer his ship through rough waters.

Total returns with an attractive income

Property: We like to run our winners, and Picton Property Income (LSE:PCTN) has achieved well-above-average NAV total returns in the UK diversified commercial property sector since it was first selected as a niche investment trust pick two years ago. 

Despite this, its shares have recently slipped to a sizeable discount, which looks good value for investors who like the security of investing in property. Moreover, it has an attractive yield of more than 4%. 

One of Picton's strengths is its management's total commitment to the trust – there are no other assets to distract them. Under chief executive Michael Morris, the portfolio has been concentrated down to 49 assets. It has a 44% exposure to industrials, where it has been doing well; nearly 35% in offices; and, thankfully, just 20% in retail, where vacancies rose last year. 

This was partly due to tenants being forced into company voluntary arrangements and partly to a Picton-initiated move to secure vacant possession of the trust's large Covent Garden property to allow extensive refurbishment prior to re-letting or sale. Despite this, overall occupancy remained above average at 94% and numbered around 350 tenants in all. Picton’s income stream is not too vulnerable to individual upsets.

Given the weakening outlook, the trust did well to sell two properties for good prices in the first half of 2018 and pay off some of its more expensive debt. This reduced its loan-to-value ratio to 25%. The company's recent move to REIT status is expected to result in cost and tax savings, which should bolster returns through what could prove a tricky phase.

Speciality property:Supermarket Income REIT (LSE:SUPR): SUPR joined our roster last year and keeps its place, as it focuses on a property sector that should prove relatively resilient, regardless of the fate of the wider UK economy. It invests in freehold and long-lease properties that are let on 'fully repairing and insuring' terms to the largest supermarket operators with upward-only, index-linked rental uplifts (collared at 0% and capped at 4-5%). To date, it has acquired six of these 'omnichannel' supermarkets, which are let to Tesco (LSE:TSCO), Sainsbury (LSE:SBRY) and Morrisons (LSE:MRW) on 19-year average unexpired lease terms. 

Supermarket Income is managed by Steve Windsor and Ben Green at Altrato Capital, which has structured and executed more than £3.5 billion of supermarket sales and leasebacks over the past decade. 

To qualify for consideration, assets must be in highly populated residential areas with strong transport links, and their operators must already be fulfilling the last mile of grocery home delivery and/or click and collect.

Additional attractions may include the potential for short-term gains through active management, such as the installation of green energy, or long-term gains via a change of use, such as redevelopment into residential property.

The managers target stable long-term, inflation-linked income as well as potential for capital gains. Both managers have substantial family shareholdings in the trust. Dividends are paid quarterly and are forecast to rise to 5.6p for the year to the end of September 2019.

Direct/fund of funds private equity:ICG Enterprise (LSE:ICGT) has made promising progress since its management team moved from Graphite Capital to ICG in February 2016. Its portfolio has been performing well: its NAV total return was 8% in the first half of 2018, thanks to strong profit growth across its largest holdings and realisations covering 14% of its portfolio at an average of 31% uplift to carrying value (an accounting measure of value). 

Meanwhile, ICG has been steadily shifting the balance of its portfolio from third-party private equity funds to high-conviction directly managed investments, which now account for 44% of the trust's portfolio. Additions of the latter have helped lift the trust's North America exposure from 14% three years ago to 24%, against a medium-term target of 30-40%. Over the same period, UK exposure fell from 45% to 32%, while exposure to Europe held steady at 40%.

The management team, led by Emma Osborne, is keen to keep ICG fully invested across the cycle, so it has forward commitments of £394 million due to be drawn over the next four to five years. Against this, it has cash of £72 million and undrawn bank facilities of £177 million. In addition, more than a third of the portfolio has been held since 2014 or earlier, so it should be ripening up for sales.

Osborne is cautious about the outlook, so investments have focused mainly on high-quality defensive businesses with non-cyclical growth drivers such as firms in the education and healthcare sectors. ICG targets a minimum dividend of 20p a year, paid quarterly and partly funded, as necessary, from capital. With its discount out to the low 20s, it keeps its place.

Income emphasis with limited capital growth prospects

Social infrastructure: Worries about a Corbyn-led Labour Party gaining power have continued to haunt the social infrastructure sector. So too have fears that leading facilities management contractors may experience similar difficulties to those Carillion suffered, leaving funds trying to find suitable replacements on acceptable terms.

On the other hand, the September takeover of John Laing Infrastructure at close to a 20% premium to NAV has demonstrated that institutional demand for social infrastructure assets remains strong, thanks to their relatively secure yields and low correlations with equities.

The net result is that shares in both International Public Partnerships (LSE:INPP) and HICL Infrastructure Company (LSE:HICL), which are the two closed-ended funds with the highest exposure to UK PFI/PPP concessions, have recovered premium ratings, but those premiums are much lower than they were a year or two ago. 

We are sticking with IPP because we like its well-diversified portfolio of 129 investments. It has much higher weightings in transport, education, justice, energy transmission and gas distribution than in health, where the merits of the PPP model are arguably most contentious. 

Moreover, the weighted average life of its concessions is relatively long at 36 years, and the income from them is mainly government-backed and based on availability rather than demand. There is a strong link between returns and inflation. An increase in returns of 0.81% a year is projected for every 1% increase in anticipated average inflation across the portfolio. The UK accounts for 71% of the portfolio, with 10% each in Australia and Belgium, and 5% in North America. 

IPP's dividend has risen steadily by about 2.5% a year since the trust's launch in 2008. It has a 7.2p target for 2019.

Renewable energy:Renewables Infrastructure Group (LSE:TRIG) is our new renewable energy choice because its diversified portfolio should make it less vulnerable than its peers to changes in increasingly unpredictable weather patterns, and shifting regulatory regimes and power markets.

Its portfolio comprises 61 investments with generating capacity of 938MW, the highest among renewable infrastructure funds. Onshore wind exposure has increased to 71%, while solar photovoltaics account for 21% of the portfolio. A battery storage facility in Broxburn, one of the UK's first utility-scale battery storage sites, accounts for 2%. This investment in battery storage – the - first by an infrastructure trust – gives TRIG exposure to a promising growth area, as does the trust's exposure to the Sheringham Shoal offshore wind farm.

Geographically, TRIG is well-diversified, with 44% of its portfolio invested in Scotland, 33% in England and Wales, 12% in France and 11% in Ireland (which operates a single electricity market). A lot of the French projects are solar, mostly in the sunny south, or Corsica, Guadaloupe or Réunion. 

TRIG's one- and three-year NAV total returns have been among the best in the renewable energy sector, and the trust should benefit in 2019 from the completion of several projects currently under construction, as well as 2018's refinancing of debt on attractive terms. Ongoing costs are competitive and a fifth of fees on the first £1billion under management is paid in shares, aligning managers' interests with those of shareholders.

Around a third of TRIG's revenue is dependent on power prices, rather than government-backed incentive schemes. As power prices have proved lower than was expected at launch, the board has dropped its commitment to raise dividends in line with inflation. However, it remains committed to a progressive dividend.

Direct lending:Hadrian's Wall Secured Investments LSE:(HWSL), launched in June 2016, has made a reasonable start, despite suffering cash drag as it built up its portfolio of loans to small and medium-sized UK businesses. 

Hadrian's Wall aims to provide shareholders with sustainable and rising quarterly dividends, and generate capital appreciation though exposure to loans secured against a variety of assets, often backed by personal, company, group or other third-party guarantees. Borrowers typically have a turnover of between £5 million and £50 million, and require loans that do not fit standardised bank lending. This helps the managers secure reasonably attractive terms, as does the fact that the typical loan size of up to £10 million is too small to interest many private equity investors. 

Managers Michael Schozer and Marc Bajer and their team at Hadrian's Wall Capital are highly experienced in debt origination, structuring, trading, portfolio management, servicing, collection and recovery. At the end of September 2018 the managers had closed loans of £121 million and a further £23 million in documentation, so the trust was close to fully invested, which should boost returns. The weighted average life of loans was 3.2 years, and the weighted average gross yield on invested assets was 9.3%. 

The recent arrangement of a £25 million revolving loan facility is expected to provide the flexibility needed to keep unused cash balances low, rather than providing permanent leverage. This year's dividend is expected to be 6p.

Venture capital trusts: Our selections include a venture capital trust (VCT) because of the enhanced income they offer taxpayers. Yields tend to be high because most VCTs distribute a mix of income and capital gains, and also because those distributions and any capital gains are tax-free, regardless of whether VCT shares were bought at issue or in the secondary market. To make the most of these benefits, we looked for a VCT that seems committed to paying a sustainably attractive yield. 

This year's choice is Albion Venture Capital Trust (LSE:AAVC), the oldest in the Albion Ventures range, which has held its distributions at 5p a year since 2010. Changes in VCT regulation mean its future investments must focus on young growth companies rather than the asset-backed companies that have helped it perform steadily in the past. However, it does not have to divest itself of the latter, and the management team has the skills to source the former, as it has been doing for other Albion VCTs for many years. 

The sector split of the portfolio is 41% in healthcare (including care homes and a Harley Street women's health clinic), 19% in renewables (including hydro, wind and rooftop solar power), 10% in education (three private schools in affluent areas), 12% in hotels, pubs and other leisure, 5% in business services (notably a fibre broadband network in central London) and 12% in cash. 

Shares can be bought in the secondary market at a small discount. Alternatively, the VCT is offering new shares on which investors can claim up to 30% income tax relief upfront.

Capital-only returns

Private equity funds of funds: The US accounts for 57% of HarbourVest Global Private Equity Trust (LSE:HVPE) portfolio, but its underlying exposure to the dollar is 79%. As a result, shareholder returns in 2019 will be substantially influenced by sterling's performance against the dollar. If you think the pound will bounce strongly, it may be wise to look elsewhere, but if you think the dollar will continue to be relatively strong, HarbourVest is one way to play it, as this fund of private equity funds has a solid 10-year performance record. 

Its well-regarded US-based management team seeks to maintain a steady flow of new and secondary investments through the cycle. However, just 19% of its $1.6 billion (£1.1 billion) investment portfolio is currently in a mature phase, so realisations – which provide the cream of private equity returns – may flag initially. Against that, with its cash holdings and available credit facilities totalling $712 million to set against estimated investment expenditure over the next three years of $1.6 billion, HarbourVest's management does not envisage problems in meeting its commitments. 

The trust's widely diversified portfolio should help protect it from upsets in any sectors. The slump in the discount from 20% a year ago to 26% at the time of writing in early January leaves it conservatively valued.

Hedge funds: Warrants and subscription shares have provided some of the most exciting returns in our roster in recent years, but there is now barely any choice. We are therefore opting instead for a hedge fund with the potential to capitalise on market turbulence.

BH Macro (LSE:BHMG) invests all its assets in the Brevan Howard Master Fund, which generates returns predominantly from directional trading in fixed income in Europe and the US, and from trading in emerging and developed market currencies using forward contracts and options. 

It flourished in 2007 and 2008 but struggled through much of the past nine years as major economies experienced synchronised growth and central banks suppressed interest rates. That financial backdrop appears to be ending, and BHM had an encouraging run in 2018, with its sterling-class shares enjoying a 3.6% NAV total return in the first 11 months of the year.

The fund's managers were humbled in 2017 when most holders of the fund’s dollar-class shares and nearly half the holders of its sterling-class shares tendered shares for redemption. The fund has responded by cutting its fees and abolishing its performance fee, while discount controls are expected to resume in April 2019. The shares could provide a welcome escape if stockmarkets have a difficult 2019.

How our 2018 niche selections performed

As the table shows, most of our niche selections achieved creditable net asset value (NAV) total returns in 2018, but their share prices were less impressive, thanks to widening discounts. 

This was particularly evident in the private equity sector, where discounts on both our recommendations have ballooned out to over 20%. One explanation is that their NAVs per share will not fully reflect the steep falls in stockmarkets until their next valuations, which in the case of ICG Enterprise Trust (LSE:ICGT) will be based on end January figures and published in the spring. Another explanation is that a lot of the unquoted companies that private equity trusts hold are highly geared, which can make their lives more difficult in an economic downturn.

Despite this we believe ICG Enterprise and HarbourVest Global Private Equity both have the skills and resources to nurse their charges through difficult times. 

The two property selections proved relatively resilient in NAV terms, but have also seen their ratings fall alongside others in their sector. Recent annual rent reviews at two of Supermarket Income REIT (LSE:SUPR) six omnichannel supermarkets achieved increases of 3 and 3.3% a year, underlining the attractive RPI-linked rental uplifts that are a feature of all its leases. Picton Property Income's very active and focused approach has helped it achieve the best five-year NAV returns in its sector, and will hopefully help it deal with current challenges to its relatively low retail exposure. 

Our equity-focused holdings were the most disappointing. Shares in River and Mercantile UK Micro Cap (LSE:RMMC) plunged 25% after the February dismissal of its founder manager Philip Rodrigs. By the end of September the shares had recovered sufficiently to be slightly up since the start of the year, before then collapsing in Q4 2018 when the Aim market was the exceptionally weak. Witan (LSE:WTAN) had a disappointing year, and we have switched to a more cautiously managed family trust for 2019. 

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.