26th January 2024
The year 2001 is a memorable one for me. My first son was born, Liverpool won the treble (ok it didn’t include the Premier League), the awful 9/11 attacks took place, and I was introduced to investment trusts for the first time. Joining a small stockbrokers in Bournemouth 23 years ago to help manage a fund of investment trusts proved to be a seminal moment with trusts becoming integral to my fund management career ever since. What I find amazing is that the sector remains just as inefficient today as it was then despite huge growth in assets and a much broader following. Back then the phrase ‘arbitrage between perception and reality’ was taught to me on day 1 as part of the process to exploit those inefficiencies and it remains just as pertinent to our approach to the sector today. Here are just a few examples (we can bore you with plenty of others if interested).
Tufton Oceanic Assets (SHIP) is my top ‘perception vs reality’ example. SHIP, an investment trust that owns and leases/charters ships, is commonly perceived as a play on global GDP which partly explains the very wide discount on which the share price trades relative to its net asset value (NAV). While that dynamic is undoubtedly a short term factor, the reality is that SHIP has always been about capturing higher charter rates caused by the structural lack of supply of suitable ships rather than a demand story. Recently sentiment has soured further by the concerning news of attacks on ships in the Red Sea. The reality is that SHIP doesn’t own any container ships (most affected vessel type), and in any case, a longer diversion to avoid the Suez Canal is a positive for charter rates and asset values, as increasing journey lengths has the same impact as removing ships from the market – it tightens supply. Even though the share price has been as bumpy as the Bay of Biscay since the launch in late 2017, it might surprise many that shareholder total returns have exceeded those of the UK equity market, and the NAV returns of 13% p.a. have exceeded the pre-IPO return expectations of 12% p.a. Last week, the Company announced the outcome of a strategic review which included a 17% increase of the dividend to 10c per share, representing a 1.5x covered 9% yield, increased its forward guidance to 15% annual returns over the next few years as the supply constraints really bite and made a commitment to investors to buy back shares if the discount remains wide, with an ultimate aim of fully realising value and returning capital to shareholders from 2028 onwards once the manager’s thesis has played out. The manager’s track record in recycling capital and selling assets at uplifts to carrying value is key in this regard, validating the NAV and proving a liquid secondary market. After that announcement, the share price remains on a 25% discount to NAV.
Sticking with alternative assets, sentiment towards Digital 9 Infrastructure and Hipgnosis Songs is so poor, caused by multiple missteps by their managers and boards, such that the extremely wide discounts today could be argued are functions of past performance rather than the very different realities today. Which involves new directors, new strategies and a set of very intolerant and demanding shareholders. After a variety of scenario analyses, we find it hard to justify such depressed share prices (cue flurry of messages telling me why the discounts on D9 and SONG are justified!).
However, the opportunities to exploit the perception versus reality are not just in the relatively complicated alternative asset classes. RM Infrastructure Income (RMII) is a portfolio of private loans where the Board accepted last year, that despite decent returns at the NAV level, its wide discount meant it was likely to be permanently sub-scale and decided to move to a managed wind-down. Proceeds from maturing loans will be returned to shareholders, with about 70% of assets likely returned by the end of this year. In these circumstances it is not difficult to calculate the return prospects for the year ahead which simply consists of some income, some capital returned close to NAV (you can apply a haircut if you want) and the pull-to-par of the discount to NAV. The share price remains on a 20% discount despite a telegraphed mid-teens total return for the next 12 months.
Another fairly straight forward example is Chrysalis (CHRY) which rode the frothy high-growth, post-Covid rally from 2020 to late 2021 generating huge returns for shareholders as the share price rose to a peak of 260p equating to a hefty 15% premium in September 2021 as sentiment moved to excessively positive levels. Since then, the share price had fallen back to as low as 50p last year, which represented a 60% discount at the time – a huge fall from grace and understandably shareholders have been pretty upset about the journey. However, while the underlying portfolio of private companies have struggled since 2022, as interest rates increased and funding for growth was harder to come by, the NAV has stabilised in recent months and the companies have been reporting good operational performance. M&A within this mature part of the private market is likely to pick up if the recent volatility of interest rates subsides in 2024 and we understand a number of the companies are preparing for IPO. In fact, in December CHRY announced it has sold one of the positions at a significant premium to carrying value (thus validating the NAV) that will add 5.5p to the NAV. Despite this news and the Board’s well-flagged shareholder consultation that will dictate the Company’s future capital allocation plans to fix the stubborn discount, the share price remains depressed and trades on a 50% discount. A quick reminder of the maths of a narrowing discount (apologies if this is obvious). A trust, like CHRY, trading on a 50% discount narrowing to 40%, with a constant NAV, generates a 20% share price return, not 10%. If you can combine that with a rising NAV then the ‘double whammy’ (another term taught to me on day 1) is even more powerful.
Daniel Lockyer – Senior Fund Manager
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