Ian Cowie discusses the income attractions of alternative assets.
Income-seeking investors struggling with low interest rates on bonds and deposits plus high share prices, should consider investment companies holding alternative assets. Infrastructure - such as public buildings funded through the private finance initiative (PFI) or sources of renewable energy such as wind farms - and many forms of commercial property can generate high and rising levels of income, sometimes with indexation or protection against inflation.
Property Direct - UK
For example, the average yield - that is, dividend income expressed as percentage of share price - in the Association of Investment Companies’ (AIC) Property Direct - UK sector is 5%. That’s more than double the 2.3% annual rate of increase in the Consumer Prices Index (CPI) in the year to March.
In addition to an inflation-busting yield, investment companies in this sector - such as F&C Commercial Property, Schroder Real Estate and Standard Life Investments Property Income - have delivered average total returns of 85% over the last five years.
This type of investment company enables individual investors of all sizes to gain access to rental income and potential capital gains that can be generated by office buildings and supermarkets, among other forms of commercial property. Each of the underlying buildings might cost several million pounds but the pooled fund structure of investment companies enables individuals who can set aside perhaps just £50 a month to obtain a stake in these assets and to share the cost of professional fund management, such as selecting sites, collecting rent and arranging maintenance.
Similarly, the Specialist: Infrastructure AIC sector enables individual investors to share predictable revenue streams from massive PFI-funded public buildings such as bridges, hospitals and schools. As governments in several countries try to avoid increasing taxes, this form of raising finance has proved increasingly popular - although it is subject to political risk from opponents of PFI who call for nationalisation. However, many of these investment companies are now reducing their exposure to UK PFI projects and have increased their investment in overseas projects, regulated utilities and other infrastructure projects to diversify their portfolios.
Funds in this sector - such as HICL Infrastructure, John Laing Infrastructure and International Public Partnerships - yield an average of 5.1%. Total returns over the last five years were 51%.
Property – Specialist
Depending on each individual investors’ attitudes to risk and reward, it might be worth considering other alternative assets. For example, the Property - Specialist sector includes companies such as the self-descriptive Empiric Student Property, Primary Health Properties and Tritax Big Box Real Estate Investment Trust (REIT). The latter fund invests in large distribution centres necessary for online shopping, a growth sector of the economy to which I recently obtained exposure via another investment company called Aberdeen Standard European Logistics Income.
Renewable Energy Infrastructure
Investors for whom ethical and environmental concerns are paramount, might prefer the Renewable Energy Infrastructure sector - which includes the Foresight Solar Fund and Greencoat UK Wind. Investors can do well by doing good, at least in terms of income, because this sector currently yields an average of 5.9%.
Alternatively, investors who are willing to accept lower yields in pursuit of capital growth may prefer the Property Direct - Europe sector where average total returns over five years were 164%, or Property Direct - UK, where average returns over five years were 85%. Another option is Property Direct - Asia Pacific, where average returns over five years were 73%.
As their names suggest, companies in these sectors invest directly in buildings in these geographical regions.
That can concentrate risk and rewards, as well as raising costs. For example, average ongoing charges in the three Property Direct sectors are, respectively, 10%, 1.8% and 12%. By contrast, TR Property, the sole fund in the Property Securities sector holds shares in other property companies, increasing diversification and reducing ongoing charges to 0.9%. Total returns over the last five years were 142%.
Benefits of investment companies
However, it is very important to understand that neither capital nor income is guaranteed with any of these funds. Asset prices can fall without warning and you might get back less than you invest. More positively, pooled funds can diminish the risk of investment by diversification - or spreading individuals’ money over many different underlying assets - and deliver other valuable advantages.
For example, investment companies have the unique ability to smooth out some of the shocks of stock markets by holding back up to 15% of returns in good years to top-up dividend distributions in bad years. This has helped 21 investment companies to raise their dividends for more than 20 consecutive years and many others can boast more than a decade of sustained, rising income for shareholders.
Another unique advantage is that the closed-end structure of investment companies means fund managers do not have to sell underlying assets to meet redemptions, if a sector falls from favour and investors want to get back into cash. This advantage can be very important with commercial property or infrastructure, where it might be difficult to turn assets into cash quickly.
More than nine years after many bond and share prices began rising in recovery from the global credit crisis - and while interest rates remain frozen near historic lows - an acceptable, sustainable income is hard to find. Alternative assets can provide answers but are not risk-free. Investment companies offer unique advantages, enabling income-seeking investors in infrastructure and property to minimise risks and maximise rewards.
Ian Cowie is a columnist at The Sunday Times.