Aberdeen Diversified Income and Growth Trust — Moving within the target

abrdn took over ADIG, founded in 1898, as manager in February 2017, following two years of disappointing performance under the management of BlackRock Income Strategies (2015–17).

Following the latest strategic review, announced in October 2020, ADIG’s investment objective is to provide income and capital appreciation over the long term through investment in a globally diversified, multi-asset portfolio, aiming to deliver a total return (defined as net asset value (NAV) growth plus dividends) of 6% pa over a rolling five-year period. This was approved by the shareholders at the AGM in February 2021 and shifted the performance measurement focus to absolute from relative.

The manager also proposed the following changes: increase exposure to alternatives and private markets (to add to the available sources of return), diversify risk exposure, reduce listed equity exposure, at the same time tilting it more to income. The strategic review also assumed increasing its exposure to private investments to c 45% of NAV over the shorter term, (complete, 47.4% at end-March 2022 versus 30% at end-November 2020) and c 55% over the longer-term. This compares with its pre-2020 strategic review long-term target of c 43%.

abrdn is targeting completion of the portfolio transition with a 55% allocation to private markets within two years.

Following the strategic review in Q420, Nalaka De Silva, head of private markets solutions at abrdn, was appointed to run ADIG, assisted by two co-portfolio managers, Jennifer Mernagh and Nic Baddeley. The managers believe the fund is structured well to continue delivering on its targets. With inflation concerns persisting, triggered further by Russia’s invasion of Ukraine, rocketing energy prices and new concerns about food price inflation, abrdn considers diversification and active management to be key to ADIG’s revised multi-asset strategy. They expect asset allocation combined with asset management to result in steady, dependable dividends, predominantly covered by recurring income.

To date, the team has struck a desirable balance between listed and unlisted credit, infrastructure and alternatives, as well as between listed and private market assets, so that the fund can offer a combination of growth, income and some inflation protection. Among other things, the well diversified portfolio creates some inflation shield as not only inflation, but also shifting expectations of inflation could have an impact on asset pricing and therefore on portfolio positioning.

At 31 May 2022, there were 643 holdings in ADIG’s portfolio, with the top 10 making up 39.0% (Exhibit 1, 35.2% in the top 10 at end-September 2021).

We present a breakdown of the company’s portfolio allocation by asset class in Exhibit 2. It shows that the team has nearly completed positioning the portfolio to its tactical asset allocation (TAA) targets, as the ‘remaining balance to reach target’ column shows. As the portfolio transformation plan is nearing completion, abrdn has been increasing the weight to private markets, looking for both capital income and growth. Cash represented 2.6% of ADIG’s NAV at end-May 2022, down from 8.0% in December 2020, as the team has been bringing the portfolio towards its targets.

The current portfolio structure is the outcome of the strategic review during the summer of 2020, and September 2020 marked the start of the portfolio’s restructuring. To simplify the presentation of the fund, the management team has recently combined listed alternatives and listed equity into a single listed equity segment. The restructured portfolio currently splits the assets into three major categories (Exhibit 2) and the team presents exposures on a look-through basis, showing asset by asset exposures. For example, where previously emerging market debt was shown on one line, the team now shows individual investment lines. abrdn believes that this structure makes the portfolio more transparent to investors.

During the past 12 months to 31 March 2022, ADIG has not sold any assets at fund level. Individual underlying funds have sold portfolio investments, for example, DWS PEIF I Fund sold Peel Ports in Q421.

Below we outline portfolio purchase activity over the last year in the three major asset clusters: private markets, listed equity and fixed income and credit.

Having made its intended investments in 2021 and Q122, by end-March 2022 the team had increased its share of the portfolio held in private market investments to 47.4% (Exhibit 2). According to management, this was achieved principally through investments in multiple sectors, including private credit (Mount Row Credit Fund II and PIMCO Private Income Fund (£10m commitment each, fully drawn). Investcorp’s Mount Row Credit Fund II is targeted at European senior secured loans, to generate consistent cash returns and strong relative value. The PIMCO Private Income Fund is primarily focused on income-producing private assets. It seeks to deploy capital fluidly across credit sectors and over economic cycles. It targets lending across the residential, commercial, speciality finance and corporate sectors. New investments also included private equity Aberdeen Standard Secondary Opportunities Fund IV ($25m commitment, 19% drawn) and Bonaccord Capital Partners ($20m commitment, 43% drawn). Bonaccord Capital Partners makes equity investments in alternative asset management companies. These provide a steady stream of income returns from management fees. abrdn believes there is upside potential for further payments from performance-related fees from this fund.

During CY21 ADIG invested in Hark III ($13m commitment, 0% drawn). Hark III provides fund financing facilities to alternative asset managers and will target lending to portfolio companies or investment vehicles that would typically require dilutive equity capital, since they generally do not meet the standalone underwriting criteria of the lenders.

During the past 12 months, ADIG invested in diversified private markets (Aberdeen Global Private Markets Fund), infrastructure (additional investment into existing funds and a new investment in the Pan European Infrastructure Fund), royalties (additional investment in HealthCare Royalty Partners IV). It also committed to the Aberdeen Standard Secondary Opportunity Fund IV (SOF IV) investment to ensure a pipeline of mature private equity assets.

According to Mernagh and Baddeley, the next step is to manage the existing commitments. In the private markets basket, the team has one more £7.5m outstanding transaction to complete, with the current focus on sourcing income-producing opportunities in the real assets space.

As the proportion of the private markets bucket has increased, the proportion in the fixed income and credit basket decreased, as the team reduced its holdings within emerging markets (EM) and frontier markets bonds, halving the position. The managers also diversified the asset-backed securities (ABS) exposure. The top holding TwentyFour Asset Backed Opportunities Fund was reduced by 1.8pp to 6.8% (see Exhibit 1). This was partially invested in Neuberger Berman CLO Income Fund (also a top 10 holding, 4.0% position in the portfolio at end-January 2022). This diversification mitigated asset concentration risk, which the team perceived to be high before this reallocation.

The other portion of funding to increase private markets’ exposure was in listed equity. The team reduced holdings in low-volatility equity strategies, making sure the equity portion is generating growth.

ADIG also reduced its exposure to listed alternatives in the listed equities segment over the last 12 months. This cluster remains diversified, including funds in the litigation finance, healthcare, insurance-linked securities, infrastructure, private equity and trade finance space. For example, ADIG owns music royalties via Round Hill Music Royalty Fund (RHM). It also has material exposure to renewable energy via a number of funds, including energy storage (Gresham House Energy Storage Fund, GRID), UK solar (Foresight Solar Fund (FSFL) and NextEnergy Solar Fund (NESF).

From February 2021, relative performance is displayed for reference only, when ADIG replaced the Libor + 5.5% benchmark. ADIG’s NAV total return (net of fees) and share price returns have improved considerably during the past 24 months following portfolio reorganisation, outperforming the Libor + 5.5% measure over 12 months to June 2021 and being very close over 12 months to June 2022. The board and the portfolio management (PM) team addressed the previous disappointing performance in the three discrete periods from the first ADIG reorganisation in 2017 through to 2020 during its Q420 strategic review and consequent portfolio restructuring.

The improving risk-adjusted performance is also evident from Exhibit 4. The risk-adjusted NAV TR (defined as NAV TR to standard deviation) in CY21 of 2.5 exceeds the 2.1 of the MSCI World GBP Hedged. This illustrates ADIG’s lower volatility approach compared to global equities.

According to the investment objective, set post-restructuring in December 2020, performance is now measured in absolute terms and targets a total return (defined as NAV growth plus dividends) of 6% pa over a rolling five-year period. The portfolio repositioning has resulted in an improved performance in the last year. Exhibit 4 illustrates that, compared to 2020 when the share price TR was negative (-5.2%) and NAV TR was flat (0.0%), in 2021 the share price TR was 6.3%, NAV 11.7% (debt at fair value) against the 6% return target. All asset classes have delivered net positive returns.

According to the management team, private markets contributed about half of NAV TR during CY21 (5.9pp). In the infrastructure segment (see Exhibit 9), a secondary pan-European power network investment was the top performer. The DWS Pan-European Infrastructure Fund I (DWS) sold its stake in Peel Ports and retuned a proportionate share of the proceeds (c €3.2m) to ADIG. DWS was sourced by the infrastructure desk. abrdn acquired the assets at a discount in Q420, making it a very good entry point. Port Group, a water utility asset, contributed c 45bp to NAV performance over the past 12 months, according to the management team.

Another large driver of performance in the private equity segment was Aberdeen Standard Secondary Opportunities Fund IV, to which ADIG committed recently and which, since ADIG’s investment, generated an internal rate of return (IRR) of more than 50%. The fund distributed $1.9m to the company in November 2021. This fund contributed c 48bp to NAV TR. In addition, a Danish company, Godt Smil, operating a chain of dentists, made a c 32bp contribution. The Aberdeen Property Secondaries Fund distributed c €3.6m back to ADIG from the proceeds of its investment in the TCAP Gemlife fund, the final remaining asset of which was a mezzanine loan secured against a portfolio of 13 retirement villages in Australia.

After March 2022, there was a significant gain from the I77 toll road asset in Aberdeen Global Infrastructure Partners II, where the fund owns express lanes into Charlotte, NC. The toll price has changed dynamically to reflect demand and, following recent testing, the forward expectation of cost per mile that can be charged is significantly higher than previously modelled, leading to a 40% uplift at the asset level, and a gain of more than 110bp in ADIG’s NAV.

The alternatives within the listed equity basket were the second largest contributor to performance (2.7pp). There were bids for John Laing Infrastructure Fund, and ADIG exited at a profit. The real estate segment, where an asset was made private at a price favourable to abrdn, also contributed positively. In the listed equities basket, MSCI World ESG tilted quantitative strategy performed well, as did the zero-fee internally managed the UK mid-cap equity fund, which follows a quality growth strategy. Despite EM debt being a drag on performance, the fixed income basket contributed 1.9pp to NAV during 2021, led by asset-backed securities. To mitigate currency fluctuations from holding EM debt, the team uses a diversified basket of currencies. For example, abrdn rotated out of a long JPY position during the year, moving to long US dollar versus the euro and the British Pound.

ADIG is a member of the Association of Investment Companies’ Flexible Investment sector, a very diverse sector by strategy. We have selected eight multi-asset peers within the AIC Flexible Investment sector that pursue an absolute return strategy and generate some income. We consider ADIG to be most similar to RIT Capital Partners, Caledonia Investments and JPMorgan Global Core Real Assets, which all have private markets exposure. Although JPMorgan Multi-Asset Growth & Income does not invest in private markets to a substantial extent, it is also a diversified multi-asset fund, whose strategies display a high degree of similarity with ADIG’s, including infrastructure, fixed income and credit and alternatives. That said, each strategy is quite distinct from the others and as such performance can diverge markedly between funds.

Exhibit 5 illustrates an improvement in ADIG’s performance relative to its peers, potentially demonstrating that the refreshed approach is working.

While ADIG’s NAV TR remains below the peer group average over the four periods shown, its progress in the peer group ranking is evident. Among the eight peers, ADIG’s ranking was up from sixth over three and five years to third over one year (compared with shortly after the portfolio restructuring) to fourth over the last six months. While its five-year returns are below the peer average, we note that this partly reflects the weak performance in 2015–17 when it was managed by BlackRock Income Strategies.

ADIG has the lowest ongoing charge among peers of 62bp. Its dividend yield of 5.8% remains clearly ahead of the peer average of 2.2%. Importantly, the dividend yield is presented on a last 12-month basis. It has remained around this level during the economic downturn triggered by the COVID-19 pandemic. We note that ADIG set an increased dividend target of 5.6p per share for FY22 (from 5.52p per share in FY21). The trust’s ongoing charges are lower than the peer average and it does not charge a performance fee. ADIG’s shares continue to trade at a double-digit discount to NAV (16.9%), which is wider than the peer average.

Since the change in strategy in 2017, ADIG has targeted a maximum discount to NAV (excluding income, with debt at fair value) of 5% in ‘normal’ market conditions. The average discount to NAV (excluding income, with debt at fair value) over the 12-month period to end-July 2021 was 15.8%, disappointingly below the target. This compares to the average five-year discount of 7.8%.

Gearing is permitted up to 20% of net assets. In the portfolio restructuring of Q420, ADIG’s cash position increased to 17.2% at end-October 2020 (from 3.3% at end-September 2020), falling to the 3% target level at end-June 2021. Net gearing (with debt at market value) was 0.4% at 31 May 2022. Net gearing reduced from 10.8% at end-October 2020, prior to the repurchase and cancellation of £43.9m of the company’s £60.0m bond in early November 2020 as part of the strategic review. The bond was repurchased at a c 54% premium to par value, which translated into a consideration of c £67.7m (excluding accrued interest) and was equivalent to reduction in NAV of c 1.55p per share. The board continues to keep the overall level of gearing under review but, in the prevailing economic environment, there is currently no intention to introduce further fixed-rate gearing.

ADIG aims to provide investors with a stable and reliable dividend stream. The trust pays quarterly dividends (in March, July, October and January) at a level consistent with the expected underlying annual portfolio yield.

For the year to 30 September 2022, the first two interim dividends of 1.4p per share each were declared. The first dividend was paid on 31 March 2022 and the second is to be paid on 14 July 2022. For the year to 30 September 2021, ADIG paid four quarterly dividends of 1.38p per share each (or 5.52p per share in total). For FY22, the board targets four 1.4p per share dividends (5.6p in total, up 1.4% year-on-year), which translates into a prospective dividend yield of 5.6% based on the end-February 2022 share price of 100.3p.

The managers highlight that during the period of recycling capital into private investments following the recent strategic review, ADIG’s dividend programme will be supported by lower interest costs after the bond repurchase and, if required, the revenue reserve. At end-March 2022, ADIG had revenue reserves of £37.0m, which we estimate was equivalent to c 2.1x its annual dividends. Over the longer term, the manager expects dividend payouts to be supported by the growing importance of unlisted holdings in the delivery of total income to ADIG’s portfolio, primarily in the form of dividend income from these assets.

ADIG aims to generate attractive long-term capital and income returns by applying a diversified multi-asset approach, using quoted and unquoted investments, with no geographical or sector restrictions. The investment process consists of a number of connected steps: research, including strategic asset allocation (SAA), tactical asset allocation (TAA); access, including idea generation in both private and public markets: and portfolio construction, using sophisticated modelling and analytic tools. The abrdn multi asset & investment solutions (MA&IS) team has 130 investment professionals, whose expertise is at the portfolio managers’ (PMs) disposal. Importantly, ADIG’s team also has access to the private markets’ teams, which provide access to deals, using their extensive networks.

Capital markets assumptions are revised twice a year. In conjunction with PM judgement, these help to inform the SAA. The team aims to invest for the long term and does not trade the portfolio on a daily basis. Although it does not trade the portfolio, it evolves positions in response to changing fundamentals, so the annual turnover in the portfolio since the restructuring remains fairly low at c 30% (source: Morningstar). As part of revised SAA work, the ADIG portfolio was reduced to three main categories to reflect the risk premia in the portfolio (before October 2020, ADIG had 14 asset categories in the portfolio):

TAA is conducted, using outputs from various forums as the strategic investment forum and various asset class steering groups. Day-to-day management ensures that the portfolio is run on the most cost-effective basis. The ongoing charge ratio (OCR) was 0.84% (at end-June 2021). The managers use the full capabilities of abrdn as a firm.

The modelling and analytics team with MA&IS provide tools that enable the PMs to view the portfolio impact on various plausible scenarios. This enables the PMs to understand inherent portfolio risks, and manage them accordingly.

While the allocation between asset classes in ADIG is determined by the three PMs, the individual asset class sleeves of the three portfolio categories are run by specialist PMs within abrdn. Exhibit 8 illustrates that the bulk of the assets (c 70%) in the portfolio is managed by abrdn. When abrdn does not manage a certain asset class picked by the PMs for ADIG, the team looks for this asset class externally.

Exhibit 8 presents the asset classes and the features sought by ADIG’s management team in the highly diverse category of private markets.