22nd March 2024
You must have been in hibernation over the past two years if you haven’t heard us and other commentators talk about the nonsensical cost disclosure rules on investment companies and its negative impact on the share prices and discounts of the sector. We have also said many times that OCFs are not the only reason behind the discounts. It is one of a few factors causing investors to flee the sector and, despite the very attractive yields on offer today, making investors reluctant to return. Those other factors include the higher yields available elsewhere making lower risk investments more attractive than they have been in decades, competing calls on free cash of individuals such as debt repayment, the consolidation of the wealth management sector pushing more money into larger and more liquid assets such as passives instruments, and certain investment trusts behaving badly causing the rest of the class to stay behind in detention. It is impossible to disaggregate the cause of discounts but using the listed infrastructure sector as an illustration of the dynamics at play, we believe we can prove the ongoing OCF disclosure rules are playing a very significant role.
We’ve done a brief ‘back of a vape packet’ analysis of the historic yield (previous 12 months dividends dividend by prevailing share price) of the archetypal bond proxy, Bilfinger Berger Global Infrastructure (BBGI), over the past few years. The current (as at 29th February) yield pick-up for BBGI over the 10 year gilt is 2.3% (6.4% vs 4.1%) which compares to just a 1.0% premium yield as at 31/12/2022 when the aftershocks of the Truss/Kwarteng debacle were still being felt. But to compare BBGI’s yield with the 10 year gilt is misleading because BBGI’s yield is a growing and arguably real yield given the underlying revenues are contractually linked to inflation. That growth has been passed on to shareholders in the form of an annualised 3.4% dividend growth since 2012 (which actually outpaces CPI over that period), while obviously the 10 year gilt is a nominal and offers nothing more. Therefore comparing the yield to the 10 year index linked gilt might be more instructive and it does show the same result with the margin over the 10 year linker currently at 5.8% (6.4% vs 0.6%) which is comfortably wider than the 4.3% spread offered on 31/12/2022 (BBGI yielded 4.7% compared to the linker yielding a paltry 0.4%).
We absolutely admit the era of TINA (there is no alternative) has moved to TIARA (there is a real alternative) with many investors wondering what is the point of investing cash into volatile listed vehicles when they could get a decent yield from a ‘riskless’ government bond or an attractive yield from their savings account. The experience of gilts losing more capital than equities in 2022 will undoubtedly have scarred many low-risk investors, who would rather not experience that pain again. But the additional yield offered by BBGI today compared to just over a year ago is too wide in our view and cannot be explained by fundamentals alone, albeit we recognise the project hand-backs might be viewed by some as a risk even if they are still some way off. We therefore think the discount has to be a result of the technicals which points the finger at the OCF issues especially since the disclosure rules were changed for UK UCITS funds to disclose the OCFs of their underlying investment companies in their own funds during the second half of 2022. It can’t be a coincidence that the popular multi-asset funds investing in the infrastructure and other real asset trusts saw their assets under management peak in the second half of 2022 and have suffered huge redemption pressures since, leading to their forced selling of perfectly good trusts like BBGI. Anecdotally, it seems as though outflows have eased somewhat and that has coincided with discounts slightly narrowing.
We have used BBGI in the example above, but the entire infrastructure sector has very attractive prospective total returns that are now in excess of government and most corporate bond funds. Following a review of the sector, we have established small initial positions in BBGI, HICL and TRIG, and have room to buy more if the technical situation continues to create these valuation anomalies. It is beholden on us to focus our efforts on investing our investors’ wealth in fundamentally sound assets that have the potential to deliver a positive real return with a sufficient margin of safety built into the valuations. Infrastructure trusts currently ticks those boxes even if they make our own funds’ OCFs look expensive compared to our multi-asset peers, many of whom have shunned investment trusts and adopted a passive approach or are investing in equities and bonds directly, which has the effect of a lower OCF. As Ben Graham once said, “in the short run, the market is a voting machine, but in the long run, it is a weighing machine” implying that fundamentals will ultimately win in the end.
Daniel Lockyer – Senior Fund Manager
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