Aurora (ARR ) has earned its third consecutive performance fee thanks to an inflation hedge and the launch of investment company Castelnau, which subsumed the UK All Companies trust’s struggling stakes in Dignity (DTY) and Hornby (HRN).

Phoenix Asset Management, which manages the deep value fund, only receives a fee if the closed-end fund outperforms the market and will benefit from the 19.1% increase in the net asset value (NAV) in 2021, outstripping the FTSE All Share benchmark’s total return of 18.3%.

Phoenix chief investment officer Gary Channon, who took over Aurora at the end of 2015, said the Covid-19 restrictions that continued into 2021 had ‘damaged’ a number of his holdings, such as airlines and hospitality stocks, as the fund was ‘well positioned for the end of restrictions and a resumption of normal economic life’.

However, the performance of the fund was saved by ‘an inexpensive hedge against the risk that the pandemic response would unleash inflation’, which turned out to be the case as UK inflation now stands at a 30-year high of 7%.

Channon (pictured) purchased the hedge last summer – only the second time the company has hedged in 24 years – and said that it increased ‘significantly’ as the inflation outlook deteriorated, ‘adding considerably’ to performance.

‘We spent 1% of the company net assets on the hedge and ultimately sold it for around 17 times that,’ he said.

‘Those proceeds now sit in the company as cash and UK treasury bills, which we will deploy into opportunities that meet our criteria, which is with a minimum of 100% of upside to their intrinsic values.

‘If we do that we will have turned 1% into at least 34%, which should more than compensate for any damage to the overall value of our businesses from the higher rates that inflation brings.’

Nevertheless, the cost-of-living crisis and volatile markets have proved difficult this year. Aurora shares have fallen 8.5% since December and stand at a 5% discount to asset value. Whit over five years it has achieved a 21% total return on net assets that is ahead of the FTSE All-Share and some of its main rivals, the 15% return to shareholders has lagged both.  

Another feature of last year was Phoenix’s launch of Castelnau (CGL ), an investment company that is now home to its small collection of special situations.

Castelnau took over the running of holdings such as funeral director Dignity, trainset maker Hornby, and collectable stamps retailer Stanley Gibbons (SGI), all of which have been detrimental to Aurora over recent years.

Channon swapped the direct holdings in the companies for shares in Castelnau when it floated.

‘Our goal at Castelnau, as it is in the rest of the portfolio, is to put your capital to work in businesses that generate high returns on it,’ he said.

Dignity has been a particular problem for Aurora, and now Castelnau, and Steve Tatters, director at Phoneix, said the group had put itself forward to replace the executive management team at the funeral services company ‘after we came to the view that the company was not collaborating as it had originally promised to do’, which was accepted.

While he said he could not report on Dignity due to the ‘inside position’, Tatters confirmed ‘that everything that has happened since we were appointed leads us to believe it was the right thing to do’.

As geopolitical and economic issues build across the world, Channon said the rocketing inflation ‘is the sort of inflation that ends up in recession as spending is diverted away from other things to cover higher energy prices’.

However, he said this scenario creates ‘less fundamental damage to the intrinsic value of the portfolio that that caused by pandemic lockdowns’.

‘Furthermore, we enter into this turbulent period with 19% of the company’s total assets in cash and cash equivalents and, as always, a roster of businesses we would like to own should they become available at attractive prices,’ he said.

Channon added that the ‘majority of the value we add’ happens in the ‘infrequent windows where markets are overwhelmed with pessimism’.