Listed income funds, in particular investment trusts, have had a tough few months.
With UK 10-year Gilts now yielding around 4% we’re seeing a massive repricing of risk. This has fed into the valuation models used by funds and investment trusts (they’re increasing their discount rates) and affected what investors demand.
If the UK government will pay you a return of 4% per year over 10 years, why take an extra private-sector risk for a yield of 4.5%? Suddenly, anything yielding below 5% looks less enticing (luckily dividend yields on equities are rising).
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This has crept up the yield ladder and even affected funds that yield substantially over 5%.
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As a result, investment trust discounts have widened, often despite relatively good news still coming from the underlying investments.
Four promising investment trusts
Take Riverstone Credit Opportunities (LSE: RCOI), which lends to a range of borrowers in the energy market, increasingly in clean energy.
The managers behind the fund have a great record and many of the loans in the portfolio have been refinanced or repaid, frequently triggering early repayment fees.
It’s a similar story with BioPharma Credit (LSE: BPCR), which lends to publicly listed life sciences companies who’d rather raise debt than issue equity at very low valuations. The trust’s repayment record is outstanding and it’s frequently making extra fees from repayments.
Both of these funds are sensibly and conservatively run, with generous yields (of 9% and 12%) respectively, and good performance histories. Riverstone is trading at a 24% discount to net asset value (NAV) and BioPharma at 7%.
EJF Investments (LSE: EJFI) is one of a handful of investment trusts that specialises in lending and debt financing rather than owning equities.
It mainly lends money to smaller US banks and insurance companies, as well as investing in mortgage-servicing rights that benefit from higher interest rates. The typical deal involves wrapping up lending within a complex package that involves different levels of risk. This could make it risky, but EJF has form in this arena and knows its segment, often managing the securitisation of the loans.
NAV has been increasing in recent months as its borrowers benefit from higher rates. In September the fund reported a monthly NAV increase of 2.5%. That took the year-to-date NAV return (including income paid out) to 17.8% and the annualised return since inception to 13%. EJF now trades on a yield of 9% and a 37% discount.
Income investment trusts trade with huge discounts
RM Infrastructure Income (LSE: RMII) has recently been shifting its strategy from direct lending to businesses to becoming more of an infrastructure-backed lender.
Its main focus is project finance: getting a development or project built before it can produce an income. Project financing comprises over 70% of the portfolio.
The fund has a senior position (or a guarantee from the government) on more than 60% of its loan book. Junior loans or other positions in the debt structure account for over a third of the portfolio.
RMII’s total net asset return over the last 12 months has been 2.73%, and since January 2020 the NAV total return has been 14.81%. The return since inception has been 35.19%. It is on at a discount of 14% and yields 8%.
It might not be the cheapest of the investment trusts in this article, but it does have some highly attractive qualities.
Buy at a discount
Back in the days of low interest rates, yields above 8% raised red flags. But the environment has changed and plenty of fairly sensible borrowers are now facing rates of between 8% and 12%.
Bonds that pay yields of between 8% and 10% will remain attractive as long as you can trust the lenders to get the money back.
Crucially, all four funds lend across a useful range of underlying sectors. Most borrowers will undoubtedly face a tough 18 months, but I think the extra risk is worth it given the yields. Additionally the chunky discounts to NAV could even begin to tighten if interest rates were to fall back in the not too distant future.
