10 funds in Caspar Rock's alternative income world
In 1686 Sir Isaac Newton first presented his Third Law: forces come in pairs, actions have reactions. This idea is as applicable to financial markets today as it was to physics in the 17th century.
The actions today come from central banks, in the name of stimulating growth and fighting deflation. There is a continuous flow of supportive policies, from printing money, through ultra-low or negative interest rates, buying large quantities of government debt to passing measures to encourage banks to further lend; the efforts are concerted and continuous.
The reaction to this post-crisis force has initially manifested itself in elevated equity market valuations and lower global government bond yields. This evolution has increased the focus of investors on alternative investments, either in an attempt to diversify their equity risk after a strong run or to find more attractive income streams to boost their retirement spending power. We believe that an allocation to these assets can play an important role in a long-term investment portfolio due to their relatively low correlation to equities and fixed income.
We profile some of our favoured selections in the alternatives asset classes that could increase diversification, boost income or do both within an investment portfolio.
Doric Nimrod Air Two
The business of commercial aircraft leasing has been going for decades, but only available in the UK investment trust market since late 2010.
DNA2 provides exposure to 7 double-decker Airbus A380s and the attractive income stream is generated through leasing the planes to the Emirates airline. The trust yields 8.37% today, driven by the 12 year non-cancellable lease contracts, giving great visibility for future income generation.
The Emirates airline is wholly owned by the government of Dubai's Investment Corporation of Dubai providing an attractive credit risk. The airline is contractually required to cover all maintenance and insurance costs throughout the life of the lease, easing investor concerns over the deterioration of the plane as an asset. As a holder of the trust you are exposed to the resale value of an A380 when the 12 year lease is up, but the current price implies a significant discount to the current estimated resale value in 2023.
Assura Group Ltd
This Real Estate Investment Trust focuses on the development, ownership and operation of primary healthcare real estate. The REIT is well diversified owning over 230 medical centres across the UK, which are backed by leases to local NHS Primary Care Trusts. Sites for modern integrated medical centres are hard to come by, and doctors do not like to move around, and this is reflected in the average lease length being 14.7 years.
With a dividend yield of 3.38%, we think this investment is potentially a good way to get access to a growing and dependable specialist property sector, supported by very attractive and growing contractual cash flows, regular rent reviews and high credit quality.
GCP Student Living
Student accommodation has received a bad press in recent years as investors have been locked in funds that are simply the wrong structure for the markets’ underlying liquidity. GCP Student Living is a fixed capital, closed-end listed investment trust, so is not directly exposed to the same issues that open ended funds have encountered.
The company has a concentrated portfolio of high specification student accommodation properties in central London and the surrounding area. The demand in the capital for student accommodation from UK and overseas students far outstrips supply, ensuring close to full capacity rental income each year. The fund currently yields 4.79%, paid on a quarterly basis, and the underlying properties benefit from the London real estate market support.
Kames Absolute Ret Bond
Money has poured in to the absolute return sector as investors worry about the prospective returns for bonds in a rising interest rate environment combined with growing fears of an equity market wobble. For a defensive allocation we invest in the Kames Absolute Return Bond fund, sitting at the low end of the risk spectrum in the universe of absolute return funds.
Run by Steve Snowden, the strategy aims to be boring, targeting around 2% per year through the investment in short dated corporate bonds, some long/short relative value credit and a small exposure to foreign exchange strategies. Performance has been incredibly consistent and achieved with very low volatility.
The current environment has been difficult for absolute return bond managers to make money, so whilst the Kames strategy returns are low in an absolute sense, it ranks very well against peers, and it’s this relative predictability that facilitates its use as a low risk diversifier to both equities and bonds.
CVC Euro Credit Partners
European floating rate investments have fallen out of favour of late as the ECB has committed to an easy monetary policy for the long term such that the prospect of interest rate rises in Europe is currently very low.
Despite this backdrop, an attractive yield and total return can still be achieved through the investment in loans issued to European corporates. CVC is a boutique investment company with its roots in private equity. It launched the European Opportunities Fund on the LSE in June 2013 to offer investors access to the low duration European loans market, as well as to offer a current annual income in the region of 4.75% and targeting a total return of 8-12%.
Loans are an attractive allocation for an investor who may have an allocation to High Yield bonds, given loans rank as more senior investments in periods of corporate stress and offer a comparable yield.
International Public Partnerships
In the age of austerity, cash-strapped governments wanting to invest in new infrastructure projects require the private sector’s support for funding and development. To encourage this activity, governments provide long-term contracts with pre-agreed payments that are often adjusted in-line with inflation.
International Public Partnership Ltd is a fund that specialises in these public-private partnership projects and has investments in 115 global projects across a variety of sectors including schools, criminal courts and hospitals.
The fund receives its government-backed revenues on the basis that the projects are available for use; rather than being related to the intensity with which the asset is used. This contrasts with “economic infrastructure” like toll roads that generates revenues based on traffic volumes and experience greater fluctuations in cash flow depending on the strength of the economy. The fund currently yields 4.59%.
John Laing Environmental Assets Group
Renewable energy infrastructure forms a key part of governments’ commitment to reduce carbon emissions in line with the Kyoto Protocol. To encourage the private sector to develop renewable energy projects, governments have offered attractive incentives in the form of subsidies.
The John Laing Environmental Assets Group (JLEN) is a diverse portfolio of wind farms, solar firms, biomass plants and waste processing plants that pays an inflation-protected income. JLEN is configured so that the majority of its earnings are subsidy based, limiting the sensitivity to wholesale electricity prices that it receives for generated energy that is sold to utility companies.
CatCo Reinsurance Opportunities Ltd
Catastrophe reinsurance is the money provided to cover the insurance claims arising from catastrophic natural disasters. Insurance companies’ credit ratings are influenced by their ability to satisfy claims, so buying protection against natural disasters improves their rating and reduces financing costs. In exchange for providing this capital, the catastrophe reinsurance company receives an insurance premium, which is the return that the investor receives if there are no catastrophic events.
CatCo Reinsurance Opportunities Ltd. is a portfolio of catastrophe reinsurance contracts that have been provided against 42 global perils, such as US wind risk, Australian earthquake risk and European flood risk. For 2015, the fund has received 17% of its NAV in premium for providing protection for the year, in the event of no catastrophes that would be the return for the year. The occurrence of an earthquake or hurricane is not correlated with financial markets so investment in this fund provides diversification benefits within a portfolio.
A ground rent is created in a contract when a freehold piece of land or a building is sold on a lease. Leaseholders are obliged to make an annual payment, known as a ground rent, to the freeholder. These payments represent a very small amount, relative to the value of the lease, but failure to pay results in the leaseholder forfeiting the property to the freeholder; therefore there is a strong incentive to pay and an extremely low default rate.
Ground Rents have pre-defined payment terms that often include a periodic increase either in-line with inflation or by a fixed multiple.
The Ground Rents Income Fund, managed by Brooks MacDonald, is a diversified portfolio of ground rent contracts that provide a defensive, income stream with a good level of inflation protection potential.
Starwood European Real Estate Finance Ltd.
Commercial property mortgages have historically been provided by the banking system, but tighter regulations on bank lending activity and greater capital requirements has reduced participation and resulted in the need for other sources of capital.
Starwood have been providing commercial mortgage finance through investment funds since 1991 and were keen to exploit the lending opportunity in Europe following the financial crisis and the resulting funding gap. The fund is comprised of mortgage loans secured on twelve high-quality properties in the UK and Northern Europe. The fund is protected from capital losses by their seniority in the credit structure, and the loans, a large portion of which are floating rate, combine to give a current portfolio yield of 5.64%.