It’s safe to say 2021 has been a good year for the investment trust industry.
Investors looking for a steady income and the ability to invest in alternative assets have piled into trusts. Data from the Association of Investment Companies shows the industry raised £14.8billion of new money this year.
Interest in renewable investment has been a strong factor but growing areas like music royalties have also proved compelling.
We look at why trusts have performed so well and what’s in store for 2022.
Why are investment trusts so popular?
Fundraising in 2021 was led by trusts focused on renewable energy, raising £3.4billion between them, including £874million in six IPOs, according to the AIC.
Their strong performance has helped to boost assets and interest. Shares in the average investment company generated a share price total return of 14.7 per cent between 1 January and 10 December, according to the AIC.
It signals a vote of confidence in the closed-ended structure which has previously been overlooked by some investors.
A trust’s structure means managers can take a longer-term view and won’t have to sell holdings to meet redemptions. It means they can also invest in illiquid assets like infrastructure, renewables and music royalties, which have all proved popular assets this year.
Another benefit investors have found is that income is less lumpy than equities. Eleven trusts feature on the AIC’s ‘Dividend Heroes’ list for increasing their dividends for more than 40 consecutive years, including City of London Investment Trust and Alliance Trust.
This is because investment trusts can put away up to 15 per cent of their income to supplement payments. During the pandemic investment companies continued to pay out during the pandemic as other companies suspended or canceled dividends.
Increased demand for investment trusts has led to some consolidation in the industry with five deals completed this year, and the recent approval of the merger of Scottish Investment Trust with JPMorgan Global Growth.
‘The record number of mergers this year suggests that investment company boards are also responding to investor demand for larger, more liquid investment companies that can deliver the benefit of economies of scale to shareholders,’ said AIC chief executive Richard Stone.
Which sectors have performed best?
The volatility of markets has seen alternative assets like unquoted companies and property become some of the most popular investment company sectors.
MUSIC ROYALTIES HIT A HIGH NOTE
One sector that has gained traction this year is music royalties. There are just two trusts: Hipgnosis Songs Fund which launched in 2018 and Round Hill Music Royalty Fund which launched last year.
Both funds buy music catalogues from labels or artists and cash in on the income generated by royalties.
The music industry is big business. The IFPI Global Music Report 2021 reported global recorded music revenues grew 7.4 per cent to $21.6billion in 2020 – the sixth consecutive year of growth for the industry.
Music has moved on from being a discretionary spend to acting more like a utility and streaming is now the largest component of recorded music revenues according to Liberum analysis.
Royalty funds have captured the attention of retail investors largely because they have little to no correlation to equity markets.
While some corners of the industry have been hit during the pandemic, Hipgnosis and Round Hill have relatively low exposure to the worst affected segments like live events, instead they focus on evergreen catalogues buying up songs from decades ago.
Round Hill has delivered a 6.5 per cent total return since listing, while rival Hipgnosis is up 8.21 per cent.
Growth Capital, which tends to invest in later stage venture capital, has proved popular as growth companies stay private for longer.
The sector, which raised £2billion this year, returned 47 per cent in the 11 months to November, compared to the average 13 per cent over the same period according to AIC data.
Ballie Gifford’s Schiehallion, which invests in later stage businesses, delivered an 109 per cent share price total return in the period, making it the second best performing trust this year.
The UK Logistics sector delivered a return of 43 per cent as it was boosted by the surge in online shopping, while the Country Specialist and Environmental Sectors delivered 31 per cent and 29 per cent respectively.
Commodities and Natural Resources trusts also had a strong showing: Geiger Counter has been the best-performing trust delivering an 111 per cent return.
The trust, which primarily focuses on uranium production, has had a good run given the conditions of the uranium market over the past year. But because of its short cap bias – 60 per cent of the fund is in small or micro cap companies – means it has managed to outperform its peers.
‘Whilst renewables are an ever-increasing component of energy supply, production is intermittent in nature, making nuclear an essential part of the energy mix, especially in meeting emissions targets,’ say managers Rob Crayfourd and Keith Watson.
‘We think that the current supply deficit is unsustainable and will drive a continued recovery in the uranium price, which will bring new projects into production, particularly as current market uncertainties are making it difficult for new projects to advance.’
Fundraising this year has unsurprisingly been led by the renewables sector as fund managers become more conscious of eco-alternatives.
Renewable trusts raised £3.4billion between them this year, including £874million in six IPOs. The most recent was the ThomasLloyd Energy Impact Trust, which focuses on renewable energy projects in Asia.
IIt started trading this month and plans to target an annual dividend yield of 2-3 per cent in 2022, rising to 5-6 per cent in 2023, and at least 7 per cent thereafter.
This momentum is unlikely to lose pace. A recent AIC poll reveals investment trust managers think the move to renewables will continue into the new year as they tip it to be the best performing asset class.
‘We see alternative energy and energy transition as sectors which will continue to thrive against the backdrop of the current economic and political climate,’ said Alex O’Cinneide, chief executive of Gore Street Capital.
‘Companies which retain flexibility to negotiate supply chain constraints will secure competitive advantage as bottlenecks and disruptions appear to be re-emerging. We place strong importance on participants being able to leverage and embed relationships with stakeholders throughout the supply chain.’
Energy storage trusts, Gresham House Energy Storage and Gore Street Energy Storage have been strong performers, this year delivering a total share price return of 22.5 per cent and 20.59 per cent, respectively.
What impact will inflation have?
While alternative energy is expected to be a big hit next year, managers continue to be concerned about the impact of inflation.
A fifth of managers polled by the AIC said it will be the biggest threat to the stock market next year, behind only rising interest rates.
Inflation has hit a 10-year high as energy, fuel and clothing costs pushed inflation to 5.1 per cent in the 12 months to November. It prompted the Bank of England to raise interest rates from 0.1 per cent to 0.25 per cent, its first increase in more than three years, as it predicted inflation could hit 6 per cent.
Nick Brind, co-manager of Polar Capital Global Financials Trust said: ‘With inflation hitting levels not seen in ten or more years we would anticipate interest rate expectations continuing to rise, which if correct should result in the [financial] sector continuing to outperform.
The BoE’s Monetary Policy Committee has warned that the latest coronavirus wave would knock the economy at the end of this year and into the first quarter of 2022.
‘Against this backdrop, income investors should look at companies with strong pricing power to protect their portfolio from inflation risks,’ said William Meadon, manager of JPMorgan Claverhouse Investment Trust.
‘It is unclear whether the market overall will show dividend growth in 2022. In this environment, the advantage of investing in investment trusts which can draw on reserves to maintain dividend payments, is clear.’
While investment trusts have no doubt grown in popularity this year, they can be more volatile meaning increased risk, and there is also a perception that shares can be difficult to buy and sell on occasion – although liquidity has improved in recent years.
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