Today I’m going to roam quite widely across a bunch of investment trusts, all of whom have been in the news over the last week or so.
First up is SQN Asset Finance. For full disclosure, I sit as a NED on a sister closed fund, the SQN Secured Income fund. But I am not connected to the Asset Finance fund in any other way nor have any unique access or insight.
But a thought does come to mind- with funds like this, it’s not the losses that count but how they are managed.
What I mean by this is that losses, defaults, and bankruptcies are inevitable when it comes to what is in effect asset-backed direct lending fund. My finger in the air estimate is that through a cycle an average default rate on an annual basis is between 1.5% and 3% but this assumes that some ‘problem’ cases are actually managed back into a profit.
So, to take a current example, SQN has been hit by a double whammy. First off it lent money to Suniva, a US solar manufacturer. After an onslaught of cheap Chinese (and South East Asian) imports, the business fell over.
Next up came bad news last week from Snoozebox. This modular accommodation provider also went into administration stating that it was “unable to agree a suitable debt servicing plan or longer-term capital structure” with SQN Asset Finance Income, its primary lender. According to Numis “SQN has announced that this development is consistent with the previously announced restructuring plans aimed at ensuring the longevity of the core assets and the full amortisation of capital with the payment of interest. Following discussions with multiple interested parties, SQN confirms that it is in “final stages of negotiations regarding the repositioning of Snoozebox’s core assets”. The Board will provide an update “in due course”.
SQN provided £10.2m of financing to Snoozebox secured on mobile modular buildings used in the hospitality industry as hotels. Following a management change, the company asked to go onto interest-only payments from September 2016 to July 2017. To cover these payments the SQN took control of the cash security deposit, which reduced its exposure to £8.2m. As at 30 June 2017, the principal balance outstanding was £7.616m, equivalent to 2.2% of the Ordinary share net assets.
For me, the two key points here are as follows:
- This isn’t a terrible surprise and has already been signalled
- That what really matters is how SQN manages their way out of this financial situation.
Investors have turned very skittish on the stock, pushing the shares down to a low of not much above 90p. But sooner or later investors will realise that these losses go with the business and that we should really judge the asset manager by how they manage their way out of this situation. In particular one would expect an active plan for capital recovery, which will probably involve SQN taking over the asset and then rebuilding value, by managing the asset – as they have done in countless other examples over the last few years. If in a year or so, they have managed their way out of Snoozebox and say Suniva, we could see the shares sharply re-rate. The contrarian in me thinks they might even be a possible buy at anything much below 92p a share.
Next up we have Capital Gearing run by Peter Spiller and Alastair Laing. I’ve long watched this fund, avoiding it at one stage because it operated with too high a premium. That premium has sensibly been sensibly managed down now and the shares trade at a much more reasonable level. Crucially the fund has also been turning in some decent numbers over the last decade, although the latest set of results weren’t exactly triumphant. During the six months to 5 October 2017, the NAV of Capital Gearing Trust rose 1.9% versus 5.2% for the FTSE All Share and 4.8% for the MSCI World Index (all total return in Sterling). Performance in the half year was impacted by a 6% weakening of the US Dollar relative to Sterling. Since 5 October, the fund’s NAV is up 0.9% versus a 0.6% rise in the FTSE All Share.
I think these short-term numbers should, though, be treated with some caution. Spiller and Laing have a very explicit capital preservation strategy, based on protecting their investors against the ravages of inflation. The fund managers also take a more value orientated approach towards buying into other funds.
Let’s take each in turn. The big macro call here – as with the Ruffer Investment Company – is a strong bet that inflation might rear its ugly head. In early April, the managers started selling their holdings of UK Treasury 0.125% index-linked 2024 at a real yield of -2.5%. with the proceeds invested in US treasury inflation protected securities (TIPS), which now make up almost a quarter of the portfolio. Now, I’m not as convinced that inflation really is a huge potential problem for the developed world. Quite the opposite in fact – I think we are only midway through a profound disinflationary bubble. But I also accept that I might be dangerously complacent and so this fund is a great inflation hedge.
As for the value strategy, I like some of the funds targeted in recent years. The managers have increased their holdings in German residential property which now makes up more than 6% of the portfolio (through holdings such as Vonovia, Deutsche Wohnen and Leg Immobilien). The fund is also invested in the Ground Rents fund, another one of my favourites. Where I beg to differ with the managers is their investment in social housing funds such as Civitas and Triple Point, where I have my real doubts. The portfolio also includes investments in Infrastructure and Renewable Energy funds, and for the first time in the company’s history, Property is a larger share of the portfolio than conventional Equity funds. According to Numis again, the largest holdings at 5 October were Vanguard FTSE Japan ETF 3.1% net assets; North Atlantic Smaller Companies 2.8%; Vonovia 2.7%; Residential Secure Income 2.0%; Deutsche Wohnen 1.9%; Unite Group 1.5%; Civitas Social Housing 1.3%; Ground Rents Income Fund 1.1%; and Foreign & Colonial IT 1.0%.
My own sense is that Capital Gearing is a sensible core holding for the more defensive investor looking for a multi asset approach that is subtly different to both Personal Assets and RIT CP> The funds track record is very impressive but I think we can safely categorise this fund as one for those who think that skies might fall in over the next few years.
Last but by no means least, we return to good old Phaunos Timber. The news came last week that the strategy to sell key assets is gaining speed. Crucially Pöyry Capital has been appointed to act on behalf of the company in the disposal of its New Zealand and South American forestry interests. A fee structure has been agreed to that is “closely aligned with shareholders’ interests”.
The board – recently reconstituted – also released an update which suggested no change in the guidance for net asset value. The last update suggested an estimated realisation NAV in the range between $229m and $286m, equivalent to $0.42c to $0.52c per share respectively. All eyes will now be on how these agents proceed in disposing of the fund’s 23% stake in New Zealand forest business Matariki – an eye-watering 49% of the NAV.