It's been a good year so far for equity issuance in the investment-trusts sector. Equity issuance is a process whereby a listed entity creates and sells shares to raise funds. Helped by rising equity markets and low bond yields, more than £4bn had been raised before the election, and the pace shows no sign of slackening. This is all good news for fund sponsors, advisers and managers, but is it positive for investors?
The record suggests not. Total issuance this year could pass the 2007 peak of £8.76bn. That was a poor time to invest, while 2009, when issuance slid to £2.6bn and net issuance (after liquidations and buybacks) was minus £2bn, was a great time to buy. But the detailed numbers are more reassuring. Only 15% of the funds raised before the election were for conventional equities, with the majority of the money going towards infrastructure or debt funds. Since the election this has continued at least 85% of the new money has gone into funds offering secure and moderately growing income, rather than capital returns.
These income funds compete with bonds and, for the most part, still look worth buying. With ten-year gilts yielding barely 1% and better-quality corporate bonds 2%-3%, the yields on offer of 4%-5%, growing at least in line with inflation, are attractive. A financing gap caused by the withdrawal of banks from non-mortgage lending after the financial crisis has created opportunities for listed funds to provide finance. A good example is BioPharma Credit, which raised $760m this year. It targets a return of 9%, including a yield of 7%, from lending to the life-sciences sector, secured by royalties or other cash flows. This is relatively risky, but the expertise of the managers should prove useful. The shares have jumped to a 10% premium over the issue price.
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Still, sponsors have a history of issuing equity until investors choke. The risks are often glossed over; these include changes in regulation, bad debts, assets not performing as expected, competition between funds pushing returns too low and higher bond yields undermining the valuations. It may not yet be time to step away, but it is a time to be careful. The best opportunities are likely to be where issuance is the lowest, which means in equities.
Those who missed the initial offerings might look at buying ScotGems (LSE: SGEM), Downing Strategic Micro-cap (LSE: DSM) or Polar Capital Global Healthcare (LSE: PCGH). The latter fund was restructured in June to extend its life to 2025, increasing the focus on capital rather than income. Additional equity was raised that more than matched those seeking to exit, and £32m of zero dividend preference shares were issued to gear up the £260m of equity (these are shares that aim to deliver a fixed amount of capital growth). Aberforth Geared Income Trust (LSE: AGIT) is also issuing zeros in its restructuring.
The discounts to net asset value at which most investment trusts trade, which widened to 10%-plus after the Brexit vote, have narrowed to around 2%. There are still huge variances though, with 3i trading at a 50% premium and some UK small-cap specialists at discounts of over 15%. In fact, discounts for UK trusts haven't narrowed this year or in the last three. Contrarians will see a buy signal; after all, the most attractive funds are usually those that aren't issuing shares.
Activist watch
The largest shareholder in Canadian lumber and paper producer Tembec says it will vote against a proposed takeover by chemical company Rayonier Advanced Materials if the purchase price isn't improved, says Scott Deveau in Bloomberg News. Oaktree Capital, which owns 19.9% of Tembec, sent a letter to both companies emphasising that the transaction is of "unique strategic value to Rayonier", and suggesting that a failure to complete the merger will mean the American company faces a "challenging future". Under the current deal, Tembec shareholders can receive either 0.2303 of a share of Rayonier, or C$4.05 in cash per share of Tembec, a 37% premium to the price before the deal was announced.
In the news this week
The Financial Conduct Authority (FCA) has set out the framework for its planned investigation into competition and value for money in the £592m online investment-platform market, says Kit Chellel in Bloomberg News. In principle, these platforms allow investors to compare products, pool their money and achieve better investment returns. However, the FCA will now look into how platforms compete in practice and whether they actually use their bargaining power to get investors a good deal. The regulator will examine both investment platforms and firms that allow investors or their advisers to access products via an online portal. An interim report should be published in the summer of 2018.
Institutional investors are increasingly putting money into alternative assets, such as property, infrastructure, private equity and hedge funds, in search of better returns, says Chris Flood in the Financial Times. Total assets managed by the 100 largest alternative investment managers rose to just over $4trn at the end of last year, up a tenth on 2015, according to the most recent Willis Towers Watson/FTfm Global Alternatives Survey. But the fact that inflows have driven up valuations across these more illiquid asset classes has raised concerns that investors may be "disappointed by future returns that are widely expected to be lower than those achieved historically".
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Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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