The past few years have been among the most challenging that most investors will have faced—whether they are running a major pension fund or an ISA portfolio. The traditional places to put your money—high-quality bonds or dividend-paying companies—have become worryingly expensive by most people’s standards and this has induced some to venture into less familiar terrain.
Among the biggest, institutional investors this “reach for yield” has seen growing demand for so-called “alternative assets.” These range from well-tenanted commercial property with predictable rental income, to more esoteric opportunities such as infrastructure (everything from oil and gas pipelines, to airports and hospitals), private equity funds (usually comprising controlling stakes in a portfolio of private companies) and funds that make loans to mid-sized companies.
These, however, are just the more conventional end of the spectrum of alternatives. Further along sit funds that own renewable energy assets (mainly solar farms and wind turbines that attract fixed government subsidies), others that lend via peer-to-peer platforms to small businesses and individuals, provide commercial mortgages and so on. Some, such as private equity, concentrate on delivering capital growth. Most others offer investors a higher income than they will find elsewhere by concentrating on specialist business lending of some sort.
For investors prepared to try the unfamiliar, the returns can be very good and the opportunity to diversify one’s risks welcome. But for big institutions there are serious challenges. Even if they can get themselves and their regulators comfortable with the risks they often hit a further hurdle: there are not enough of these assets available to soak up the sums they might like to invest.
That, however, is not an issue for the average DIY investor and the London Stock Exchange has at least one investment trust for almost every sort alternative that exists. These trusts offer a very convenient way for private investors to gain exposure to under-lying assets that tend to be very illiquid (meaning that they can be time-consuming and expensive to buy and sell), but to do so by buying shares in a holding company that are much quicker and easier to trade.
This “liquidity mismatch” has one common side-effect: shares in these investment trusts generally trade at a discount to the stated value of the assets they own—be they airports, solar farms, corporate loans or stakes in private businesses. A discount can indicate doubts over the true value of the trust’s holdings, but it mostly reflects nothing more sinister than investors’ demand for a reward to offset the risk of holding more illiquid assets: the discount enables them to buy assets valued at X for a bit less than X.
In some areas at the moment, such as private equity trusts, these discounts are unusually wide and range from 20 per cent upwards. Although there is no guarantee that they will reduce again rather than expanding, I for one would rather buy at a discount than pay a premium.
