In a world of prolonged and abnormally ultra-low interest rates, investors seeking income have been pushed away from historical areas of comfort. Low Gilt yields initially pushed investors into riskier assets such as corporate credit, commercial property and even equities. But as spreads in corporate bonds have narrowed and rental yields fall, we have seen increasing appetite for more esoteric asset classes designed to meet demand for income.
Investment trust providers have risen to the challenge, either by launching funds – raising capital from investors and listing on an exchange, of which Neil Woodford’s Patient Capital Trust (WPCT) was a recent and notable example – or by selling shares in the secondary market to meet ongoing investor demand.
Alternative Income Options Flood the Market
Over the past 12 months to August 2017 investment trusts have raised £9.6 billion from investors in these two ways – known as issuance. Of this, 74% has been within what could broadly be termed alternative income; those assets not directly comparable to equities or conventional bonds and which distribute a structured yield to shareholders.
Issuance in what could be termed conventional income, such as multi-asset or UK and global equity income trusts, totalled £668 million. Finsbury Growth & Income (FGT) led the way with £112 million of issuance. Conventional issuance amounted for around £950 million which was dominated by activity in the secondary market from Scottish Mortgage (SMT) £299 million. Alternative income accounted for the remaining £7.2 billion.
Closed-end Fund Structure Stands Up
The structure of closed ended investment companies is ideal for investment into alternative asset classes, especially where regular investor distributions are a predominant objective. The ability to gear – a form of borrowing, utilise income, and capital reserves to smooth and boost distributions helps. As does not having to meet investor redemptions. Because of this, the closed-end structure is arguably the only way to invest into these esoteric and illiquid asset classes.
In recent years there have been new company launches into areas such as infrastructure, specialist commercial and residential property – student accommodation, medical, logistics and storage, renewable energy, airline and oil rig leasing, alternative credit, asset backed investments and peer to peer lending.
Investors, and their advisers, must decide if these investments are suitable to form part of a diversified portfolio. But as a sage colleague used to regularly say: investors want to have their cake and eat it too. In other words, a high headline rate of distribution comes with a range of potential risks; defaults, interest rate sensitivity, discount volatility, regulatory and taxation concerns, liquidity and ultimately potential capital erosion. As always, investors should tread carefully and seek professional advice where necessary.
