A couple of weeks ago I flagged an email from a Citywire reader who was also a leading fund manager. It was based on my enthusiasm – in my Citywire columns – for the fund of fund open ended funds Gravis UK Infra and Foresight Infra, which invest in a diversified basket of underlying infra funds. The anonymous fund manager raised some interesting issues which I have now mapped out in a Money Week column – you can read it here.

In that latter article I have tried to include a mix of responses from the fund managers concerned but because, as you’d expect, we’re short of space in MoneyWeek, I’ve decided to include the full responses in this blog. I make no comment and have added no edits that interfere with the arguments and leave it to readers to come to their own conclusions. But as I said in my MW piece I am still an enthusiast for these simple to understand funds, despite some concerns.

First off, we have a series of responses from Mark Brennan, Lead Fund Manager for Foresight UK Infrastructure Income Fund.

The investment trust market is not that liquid even at the best of times!

The weighted average market capitalisation of FIIF’s portfolio is £1.5bn, and at 25% of ADV an average c.£1.6m worth of shares trade each day per trust- significantly more than we usually need to trade. Furthermore, we have historically traded roughly 1/3 of all volume off-exchange either through tap issues, placings or alternative execution venues (dark pools etc), so our price impact is minimal.

In recent months, the premia at the trusts held by these funds has become correlated with the growth in their assets.

Take our investment in Sequoia Economic Infrastructure Income Fund (“SEQI”), for example. In the 12 months to 28 February 2020 we grew our position by from 9m shares to 45m shares, ending the period with 2.8% of the register. Over the same period, SEQI’s premium to NAV ranged between  6.6% and 11.6%, and in the five months to February 2020 (where we grew our holding by 19m shares) the premium to NAV actually decreased by 5% (also 2% lower than March 2019).

Another example where we have avoided buying into a growing premium is Greencoat UK Wind (“UKW”). During 2019 the premium to NAV grew from c.3% to 23% by the end of December. We actually reduced our exposure to UKW as we saw valuation become excessive, tapering the fund’s allocation from 8.8% down to 3.8% over the course of 2019.

Daily dealing funds are now owning a large proportion of closed end fund shares? 

We hold less than 5% of the issued share capital of all our holdings. Our average ownership level is 2% of issued share capital. We wouldn’t see those levels as ‘an awful lot’, although I note that GCP UK Infrastructure Income Fund does hold more than 5% of some of its portfolio holdings. However, we have been deliberately disciplined in keeping our concentration below 5%.

Aren’t the funds forced buyers of their trusts when they receive subscriptions and in turn, they might be setting the price for these trusts?

We are a minority buyer of the trusts we hold, having gradually built our <5% positions over several years, so I think it’s hard to make the argument that we are setting the price.

Our trading and portfolio strategy is dynamic and we continually assess what trusts we invest in and at what levels. Any comparison of the portfolio over time will show that the target allocations have regularly adapted and changed. We do not just blindly buy our portfolio as we raise money. Recent portfolio adjustments have included reducing exposure to UK renewables during the second half of 2019 in reaction to pricing and valuation, as well as increasing exposure to core infrastructure as the UK general election approached in December where premium levels were very attractive.

Is the open-ended structure being used well here, and they are becoming rather too important on the registers of these trusts?

We hold less than 5% of the issued share capital of all our holdings, and whilst we do not think we are ‘too important’ we are able to use our influence positively to engage with Boards and management teams in the interests of our unit holders.

Next up we have a very detailed reply from William MacLeod, MD at Gravis Advisory…

There are two funds which you have recommended and which directly invest in the sector and whilst there is some overlap between their respective portfolios, we consider that to be common for vehicles investing in similar sectors/strategies; for example the majority of UK equity income funds will own at least one of BP and Shell. Even so, we believe the comment is misrepresentative of the extent to which an overlap occurs. For context, the VT Gravis UK Infrastructure Income Fund (“The Fund”/or “Gravis UK Infra”) is currently invested in 27 individual securities, however, only eleven of these are common to both the VT Gravis and the Foresight fund (based on publicly available information).

The VT Gravis UK Infrastructure Income Fund invests in a range of security types including closed-ended investment companies (CEICs) and Real Estate Investment Trusts (REITs) and also in traditional equities and direct debt issues, we do not consider the Fund to be a fund of funds. But just taking those to which the comments refer, the Fund’s investments in CEICs and REITs amount to c.£485m, within an identified universe of relevant companies valued at well over £30bn. Were the entire investible universe to be included it would be apparent that it is far larger and more liquid than just the investment trusts or CEICs, to which the comments refer. We disagree with the comment that ‘the investment trust market is not that liquid even at the best of times’: 11 CEICs and REITs held by the Fund (or c.63% of the Fund’s total CEIC/REIT exposure) are members of the FTSE 250 Index with natural daily traded volumes in the millions.

We’re flattered, but don’t agree that the Gravis Fund is likely to act as a price setter. In the year to date the Fund has traded a total of 2,064,400 shares of TRIG and 5,423,131 shares of HICL, figures which are rather insignificant in the context of the traded volumes in these companies across all trading venues over the same period being c.635 million shares of TRIG and c.480m shares of HICL. Our market intelligence suggests that the price setters (i.e. the marginal buyers/sellers) are typically wealth managers, DFMs and direct retail investors. Furthermore, the Fund is not a forced buyer. That would suggest inflows to the Fund are simply pro-rated across the existing portfolio, whereas, careful assessment drives investment decisions on a day to day basis and the Fund has at times held significant tactical cash balances awaiting the opportune time for deployment. It is a sizeable and diverse universe that does not trade homogenously.

The Fund provides an option for those seeking exposure to the now very sizeable, broad and complex UK listed infrastructure sector. The Fund has a very clear return objective with a focus on income and since launch in January 2016 the Fund has delivered very attractive risk-adjusted returns for unitholders, in line with the strategy’s aims. Further, the Fund has enabled thousands of investors, who are advised by thoughtful and active IFAs, to gain access to the asset class, which otherwise would have been inaccessible. Client money advised by IFAs is very rarely able to invest in anything other than open ended structures and without these funds they would have been precluded from investing in the infrastructure sector which was originally the preserve of the elite and institutional investors. The types of assets and concessions owned by infrastructure companies, and the discounted cash flow models used to value these assets, naturally lend themselves to being held within a closed-end structure, so the open ended structures which spread the risk and provide unique access to the sector is valuable, innovative and democratising.

Both funds mentioned invest in infrastructure companies advised by their parent companies, which charge management fees. The shares issued by any company listed on the London Stock Exchange can be bought and held by investors and if they were not held by the funds, they would be held by other investors. The issued shares in GCP Infrastructure Investments (GCP LN) or Foresight Solar Income Fund (FSFL LN), for example, represent permanent capital. That is to say that once the shares have been issued the capital they represent will attract fees regardless of who owns them, whether that be the VT Gravis Fund or anyone else. It seems wholly unfair to criticise a fund management group which has actively sought to bring the asset class to the widest possible audience and to then make additional criticisms when the returns have met expectations whilst the fees have been suppressed and capped for the benefit of all.

As long term investors in the sector, regarded by many as consistently meeting investors’ expectations, we believe the Fund and its adviser are regarded as supportive, responsible and knowledgeable and welcomed as stakeholders in these entities.

Addressing the commentator’s observations about investing in renewable energy assets, our view is that value is derived from the contracted cash flows owned by the asset operators. In the UK renewables market a large proportion of existing cash flows are underpinned by subsidy mechanisms that not only provide significant visibility over future cash flow expectations but are also indexed to inflation. Market price exposure may be sold forward at opportune times. Meanwhile, new offshore wind capacity (the key current focus of new UK renewables capacity) is underpinned by a CFD mechanism which provides long-term fixed pricing for the electricity generated. The UK renewables market is evolving and as more unsubsidised solar/onshore wind assets are commissioned – where the trajectory of merchant power prices becomes increasingly important – the power purchase market will also need to evolve and possibly move more in line with other jurisdictions like North America where decentralised renewable energy assets have long-term fixed price power purchase agreements with a range of off-takers. Furthermore, the marginal price setter of UK electricity is still gas generation, not renewables.

Since inception, we have taken care to manage investors’ money as carefully and diligently as any other in the market, whilst charging our investors very modest costs and with nothing hidden from view. In our efforts to innovate and provide investors with an alternative to equities, property, bonds and cash, all of which are showing signs of stress, we would expect to take some criticism. It’s important to note that this is not a competitor as they do not appear to have invested in the sector and may feel they’ve missed the opportunity to harness the relatively stable, dependable returns from this sector. The Fund is open and they are welcome to invest.