Unloved alternative trusts are going cheap – should you buy?

Investment trusts have several attributes that make them appealing to investors, but one of the most valuable is their closed-ended nature. Trusts are structured as companies, with a fixed number of shares in issue. Unlike open-ended funds, they don’t need to buy and sell assets due to cash flowing into and out of the fund as demand from investors changes. This means they can take a longer-term view and hold illiquid or difficult-to-sell assets.

This advantage has helped the alternatives segment of the market flourish. Alternative funds offer private investors easy access to a wide range of investments, including private equity, infrastructure, hedge funds and specialist debt.

However, over the past five years, many of these funds have fallen by the wayside. Complications with cost-disclosure rules, the shift away from smaller trusts and a general lack of interest in the UK market have all combined to send valuations plunging.

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Infrastructure trusts are now trading at an average discount of 24.2%, even though they offer a market-beating average yield of 4.6% according to data from broker Panmure Liberum. Among renewables infrastructure trusts, the discount is even wider at 34.5% and a yield of 8.6%.

Infrastructure-debt funds are on an average discount of 22.5% and a yield of 9.2%, while the average discount in private equity funds-of-funds segment is 34.5%.

By comparison, the average investment trust (excluding 3i, which is very large and trades at a huge structural premium) was trading at a discount of 15.2% at the end of May, according to broker Winterflood. That average was itself skewed by the alternatives trusts, since the average global equity investment trust trades on a 7.1% discount.

Validating NAVs

Unlike equity-focused trusts, whose net asset value (NAV) will fluctuate in line with stock markets, most alternatives have a relatively stable NAV. The question is whether these reported NAVs are realistic.

Some recent deals in the sector are encouraging in terms of validating NAVs. BBGI Global Infrastructure was taken over at an offer price of 147.5p (including a final dividend) – a 3.4% premium to BBGI’s estimated NAV of 142.7p at 31 December.

In real estate, the value is even more apparent. Several deals have been announced in the sector this year, and the latest two – Assura/PHP and Unite/Empiric Student – show the vast gulf between the price that funds have been trading on and what strategic buyers are willing to pay in some cases.

For Empiric Student, Unite has offered the equivalent of 107p. This is a premium to the sub-100p price before the offer, even if it is still some way below the last reported NAV of 120.7p. Meanwhile, Assura has been the subject of a bidding war between PHP and private equity giant KKR at around NAV. Before rumours of an offer emerged, Assura was trading at roughly 70% of NAV.

Unlikely to last

The market is slowly waking up to this. UK real estate investment trusts (Reits) have chalked up some of the best performances of any investment trust vehicle in the past year. Still, Reits remain on a double-digit discount to NAV on average, and most offer a high single-digit yield.

With the number of deals accelerating, it seems that it will only be a matter of time before more value is realised in the sector. Buying purely in the hope of a takeover is never a sensible option, but here investors can also buy into trusts that appear deeply undervalued and offer attractive yields at a time when interest rates are falling.

As more alternative funds get taken out, this opportunity may not last for long. Cheap trusts will either get bought up or start to trade on higher valuations. However, while the opportunity is still around, it’s worth adding some exposure in a portfolio.

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