Two adventurous income plays

Cultation in a GP surgery © iStock
GP surgeries are an unlikely target for renationalisation

It’s time to add two more holdings to the income portfolios I’m building. Both are specialist funds listed on the London Stock Exchange that come with a slightly higher level of risk, so they will sit in the more adventurous portfolio.

Sequoia Economic Infrastructure Income Fund (LSE: SEQI) invests in private debt and securities in the infrastructure sector. Unlike peers such as HICL, INPP and GCP, which mostly invest in public-private partnerships (PPP) such as schools and hospitals, SEQI largely invests in private infrastructure assets (roads, data centres and energy). For example, its third-biggest holding is a £37m investment in the senior debt of IO Data Centres, which runs buildings full of internet servers in places as varied as Ohio and Singapore.

That loan has a high yield of 9%, but other big loans in the book of 50 investments include one to a road business (much lower risk and lower yield), an undersea cable outfit and a waste-to-energy specialist. The average loan size is £12m with an average life of 4.8 years, and 58% are on a floating rate (so the yield could go up if inflation starts rising). The overall portfolio yield to maturity on the loan book is 8%.

On paper, SEQI’s focus on private infrastructure could be much riskier than the government-backed assets run by other infrastructure funds. But I think the focus on private businesses and the wide diversification of borrowers is a positive thing. There’s no obvious renationalisation risk as there is with UK PPP assets at the moment.

SEQI trades at a 6.75% premium to net asset value (NAV). There is some chance of a small decline in NAV if interest rates rise – the fund estimates a possible 2% decline for a one percentage point rise in rates – but that might be balanced out by steady progress in its build-up of loan assets. At the current price it yields 5.3%. That’s lower than the 6% level I’d prefer, but the fund should fit nicely in most adventurous income portfolios.

A solid yield and a capital gain

The second fund is MedicX (LSE: MXF). This trades at a 10% premium to NAV, which makes me a little cautious, but the running yield is still 7.2%. MedicX invests in medical infrastructure – eg, new GP surgeries leased back to the doctors. Even if one takes the most cautious view about the impact on PPP of a Labour victory in the next general election, I think GP surgeries are the least likely target. Many voters may seethe about badly structured hospital deals, but I’ve seen next to no resentment about the provision of private capital for GP centres (remember GPs are themselves private contractors).

MedicX’s investments consists of 156 modern purpose-built assets, with a value of £680m. It has a £175m pipeline of potential deals, with £90m in Ireland where it is diversifying because yields are higher. The fund is operating with 50% gearing and its loans have an average maturity of 12.7 years – close to the remaining lease term of 14.1 years on its properties – with an average cost of debt of 4.3%. So its financial position looks relatively secure.

The fund’s dividend is only 70% covered at present, but the development pipeline should start to kick in extra cash. My hunch is that as that happens and the yield starts to be covered, the shares might rise until the yield is closer to that of its main peers – Primary Health Properties and Assura – which yield closer to 5%.


Activist watch

Hedge funds that try to persuade US courts to boost the price of a takeover after the deal closes have suffered a big setback, says Sujeet Indap in the Financial Times. The activists’ strategy, dubbed “appraisal arbitrage”, involves suing the buyer to challenge the fairness of the price. Funds such as Merion Capital and Magnetar raised more than $1bn to fund cases, leading to one in five eligible deals facing a lawsuit in 2016.

But the Supreme Court in the state of Delaware – where most US firms are incorporated – threw out an award made by a lower court over the $24bn takeover of computer firm Dell in 2013 and set narrower guidance on when a price is fair. The verdict may spell “game over” for most funds following the strategy, says Indap.

Short positions… leaseholds on shaky ground

• Shares in Ground Rents Income Fund fell 11% last year amid the government crackdown on leaseholds, says Gavin Lumsden on Citywire. In September the investment trust – which buys freeholds in residential and commercial properties – said it would offer any leaseholders whose rents are set to double at each rent review the option to switch to inflation-linked rents. It later reported that 69% of its leases are already inflation-linked and outside the scope of the government’s review.

But after the government said last month that it will rush in laws banning leaseholds on new houses and helping leaseholders on onerous contracts get compensation, the fund said it would pause its programme to analyse the statement; its shares then fell a further 3%. Investors clearly fear new laws threaten the viability of the five-year-old trust.

• Many UK equity income funds are no longer doing what their investors expect, says Robin Geffen in Money Observer. In March, the Investment Association – the fund managers’ trade body – cut the target yield for this sector from 110% to 100% of the yield on the FTSE All-Share index. Many managers quickly reduced the yield on their portfolios, presumably in pursuit of more growth. Almost 20% of UK equity income funds now yield less than the FTSE All-Share. “Should a fund that yields less than the market really have the term ‘income’ in its title?”