Henderson Alternative Strategies Trust — More defensive in response to macro headwinds

Equity markets around the world have seen higher levels of volatility so far in 2018 than in recent years. While earnings growth has remained positive (particularly in the US, where generous tax cuts have provided a temporary boost), investors have arguably begun to focus more on the risks – rising interest rates and inflation, trade tensions and political uncertainty – than on the potential rewards. As shown in Exhibit 2 (left-hand side), global equities, here represented by the MSCI World index, have outperformed other asset classes in sterling terms over the past five years, but have been significantly more volatile and have also seen a sharp downturn in recent weeks. In contrast, performance of alternative assets such as private equity, property and hedge funds (measured by the appropriate Datastream investment trust indices) has been much steadier, albeit less impressive in absolute terms. One consequence of the recent equity market sell-off is that forward P/E valuations in both developed and emerging markets (Exhibit 2, right-hand side) now look more appealing versus their five-year averages, suggesting positive returns may still be achievable for investors who take a selective approach and focus on avoiding ‘value traps’. However, with the balance of sentiment seemingly having tipped from greed to fear, investors may wish to consider an allocation to less volatile assets away from mainstream equity markets, to provide a source of diversification if the current mood of uncertainty persists.

Launched in 1991 as the Scottish Value Trust (later SVM Global Fund), HAST has been managed by Janus Henderson Investors since April 2013. Initially known as Henderson Value Trust, it changed to its current name in 2015 to reflect its focus on specialist and alternative assets. The move to Henderson came after a period of poor performance, and HAST’s management team took time to transition the portfolio steadily into its current focused selection of third-party funds and companies, under five broad headings of specialist sector, specialist geography, private equity, hedge funds and property. Until recently, HAST was co-managed by Ian Barrass and James de Bunsen, assisted by Peter Webster. Following Barrass’s retirement on health grounds in June 2018, Webster has stepped up as co-manager alongside de Bunsen.

The idea of HAST in its rebuilt form is to seek to achieve long-term returns in excess of those from global equity markets, from a portfolio mainly made up of open- and closed-ended funds that individual investors would be unlikely or unable to own by themselves. At least three-quarters of the 30- to 40-holding portfolio is held in core, long-term investments, although the managers may also take more opportunistic positions. Every holding should have the potential to achieve returns of between 8% and 20% a year, and the overall portfolio has a target NAV total return of 8% a year, measured over rolling three-year periods. HAST’s managers stress that it is not an ‘absolute return’ mandate in the sense of seeking to avoid capital loss (possibly at the expense of upside potential), but rather a fund that seeks to achieve its returns through well-managed exposure to risk.

HAST is a member of the Association of Investment Companies’ Flexible Investment sector. It measures its performance against the FTSE World index (in sterling terms), as well as versus its informal, long-term annualised 8% target return. Underlying holdings may use gearing, but HAST itself is ungeared. The fund also aims to pay a growing dividend.

Earlier in 2018, HAST announced its intention to move its year end from 30 September to 31 March, to align its year-end reporting schedule more closely with the reporting dates of private equity and other unquoted investments in the portfolio. It has extended FY18 to an 18-month FY18/19, ending on 31 March 2019. During this period it will produce two sets of interim accounts, for the six months ending 31 March and the six months ending 30 September 2018.

The managers’ cautious outlook on global equity markets would seem to have been vindicated by the sharp recent downturn (FTSE World index total return of -7.7% from 1 October to 20 November). De Bunsen points out that for the first eight months of 2018, the FTSE World index was driven almost entirely by the US equity market, which accounted for more than 90% of the index’s positive return (versus its 57% index weighting), buoyed by demand for the US dollar. HAST has little mainstream US equity exposure, which has held back the fund’s relative performance as the market has risen, but the managers note that this could prove defensive if the downturn persists.

HAST’s NAV performance held up well in the generalised equity market volatility seen in February and March 2018. Since then, de Bunsen and Webster have been rotating into more defensive areas, although given their ‘specialist and alternative’ mandate, the managers explain that they cannot hold large amounts of cash or government bonds. Instead, they have increased exposure to hedge funds that are less sensitive to equity market movements, at the expense of listed private equity and higher-risk credit funds.

De Bunsen says that the US market has been at ‘peak earnings growth and peak tax reform’, with high valuations. ‘It is not healthy only to have one geography – and within that, very few sectors – performing well,’ he argues. ‘Earnings have been stellar on the back of a one-off tax impact, but the sugar rush will fade as interest rates go up and multiples contract, and you don’t need concrete signs of a recession for the tailwind to go from the market.’ Webster adds that even before the recent sell-off, there were clear signs of a shift in sentiment, with broker notes having gone from bullish to bearish. The global move towards tighter monetary policy, ongoing trade tensions driven by the US, the fragile state of the Brexit negotiations, and continued political uncertainty emanating from Italy all feed into the managers’ more defensive positioning.

HAST’s managers, James de Bunsen and Peter Webster, are part of Janus Henderson’s multi-asset team, with responsibility for alternative strategies. They each have more than a decade of investment management experience. HAST aims to provide a one-stop shop for investors seeking a differentiated portfolio of alternative assets that are niche, specialist or hard to access. In performance terms, it looks to exceed average global equity market returns (c 8% per year) over the medium to long term.

The portfolio is split broadly into six categories (see Exhibit 3 for current strategy split). Private equity has historically outperformed listed markets over the long term, and HAST’s fund selections offer access to early-stage, high-growth companies and buyouts. Hedge fund strategies can protect capital during volatile periods, and the chosen funds offer access to a diversified pool of differentiated strategies. Property exposure is focused on specific growth sectors to help reduce correlation with global property values, with the fund’s holdings angled away from the UK prime commercial property market and towards niche, specialist and higher-return areas. Public equity aims to give exposure to secular growth and tactical opportunities in specialist areas of listed markets. HAST’s managers are able to draw on the expertise of the wider multi-asset team to invest by sector or geography. Credit investments are focused away from mainstream government and corporate bonds, and instead aim to capitalise on the growth in alternative finance providers as a result of bank disintermediation. Finally, commodities provide potential for uncorrelated returns, particularly when accessed through specialist strategies.

While the categories have been updated to provide a more informative overview of HAST’s holdings (the previous classifications of specialist sector and specialist geography have been replaced with the new categories of public equity, credit and commodities), the risk limits for each segment remain unchanged: private equity exposure from 0% to 35%, hedge fund exposure from 0% to 30%, property exposure from 0% to 20%, a maximum of 20% in any single sector, and a maximum of 50% in emerging markets.

HAST’s investment process is broadly split into three stages:

At 31 March 2018, there were 36 holdings in the HAST portfolio (excluding a small number of residual positions of negligible value), compared with 37 a year earlier. The full portfolio is published twice-yearly, at the annual and interim results. At 31 October 2018, the top 10 positions made up 46.9% of the total (see Exhibit 1), a little higher than 44.6% a year previously. The managers’ intention is to maintain a portfolio of 30-40 investments, with at least three-quarters in core, long-term holdings, leaving scope for some more opportunistic tactical positions.

HAST presents the split of portfolio exposures in a number of ways: by fund/vehicle type (see Exhibit 1), by strategy (Exhibit 3), and on a look-through basis by sector and geography (Exhibit 4). The board and managers are considering alternative ways of presenting this analysis; for instance, de Bunsen says having one category of listed/liquid, for open- and closed-ended funds with daily liquidity (this now covers c 90% of the portfolio following Ceiba Investments’ London IPO), and another of unlisted/illiquid would give investors a more accurate picture of underlying liquidity.

In the 12 months to 30 September 2018, the biggest changes in terms of the structure of underlying holdings has been a 2.0% reduction in listed vehicles on major exchanges, and a 3.0% increase in unlisted vehicles with redemption rights. This has mainly been as a result of exits from some closed-ended specialist debt funds, and the switch from the closed-ended Genesis Emerging Markets Fund to the open-ended Sloane Robinson Emerging Markets Fund. In terms of the strategy splits in Exhibit 3, credit exposure has fallen by 5.0pp, again mainly as a result of exits from credit (and particularly collateralised loan obligation, or CLO) funds. Blackstone GSO Loan Financing and Chenavari Capital Solutions were sold, while the position in Chenavari Toro was trimmed. The managers say they may revisit CLOs in the event of a sell-off in the sector. The other strategies all saw small increases as a result of the specialist sector reduction.

However, since March, the managers have opened a specialist sector position in a commodities-linked investment, now in the top 10 holdings. The investment, structured as a Luxembourg-listed certificate, aims to exploit inefficiencies in commodity markets. De Bunsen explains that passive investors in commodities (who buy the nearest futures contract and roll forward into the next one before it expires) typically buy higher than they sell, because the price curve for futures slopes upwards due to storage costs. This is known as the ‘negative roll yield’. The HAST investment, linked to the Bank of America Merrill Lynch (BofAML) commodities desk, takes a short position in the near-term contract and goes long further out the price curve, providing a positive return as the storage costs priced into the longer-dated contracts are less than the negative roll yield on the near-term contracts. While this is HAST’s first investment in the strategy, it is well known to the team, having been included in de Bunsen’s other portfolios over the past 10 years. Another new specialist sector investment is litigation finance fund Burford Capital, added in October 2018. In more mainstream equity market exposure, the managers also bought Euro Stoxx 50 dividend futures, believing they can generate double-digit returns with below-market volatility.

On a look-through sector basis (Exhibit 4, left-hand chart), the biggest changes in exposure over 12 months to 31 October 2018 were increases in financials and banks (+2.8pp) and property (+1.3pp) and reductions in personal goods & retail (-1.9pp) and miscellaneous (-2.1%). New property holdings include private rented housing developer/fund manager Sigma Capital (covered in our last note) and Urban Logistics REIT (SHED), a warehouse and logistics fund focusing on last-mile distribution. De Bunsen says SHED is in a growing segment, has an asset management angle and an excellent, specialist management team, and should be able to make double-digit returns for the next couple of years. In financials & banks, as well as the purchase of Burford Capital, the team added to HAST’s holding in Axiom European Financial Debt Fund, which was able to pick up good assets cheaply after this year’s Italian election sparked a sell-off in bank debt and topped up the position in Polar Capital Global Financials Trust.

In geographical terms (Exhibit 4, right-hand chart), most defined geographical areas saw a small reduction in exposure (0.2–2.1pp) over the 12 months to 31 October, while the ‘miscellaneous’ category saw a 5.0pp increase (including 4.3pp in the BofAML commodity investment).

A number of other changes took place in the portfolio. The long-standing holding in Baring Vostok (a private equity fund focused on Russia) was trimmed to limit exposure to currency volatility. While the position in EF Realisation was sold (see Performance section), the managers topped up another vehicle in realisation phase, Safeguard Scientifics. De Bunsen said the market had focused too much on the write-downs or disappointing sale prices of some of Safeguard’s smaller holdings, and not enough on the sale of 40% of its prize asset, MediaMath. HAST’s managers believe there is still 65% upside potential on the remaining businesses, based on conservative exit multiples, although the exits could take two to three years to achieve (implying returns of c 20% a year).

A recent tactical theme in the HAST portfolio has been infrastructure funds. The managers bought International Public Partnerships (INPP) and 3i Infrastructure (3IN) in early 2018, and HICL Infrastructure (HICL) in the second quarter. Although these funds have been trading at a premium to NAV, de Bunsen believes the NAVs understate the true value of the assets. The holding in 3IN was sold earlier this year following very strong performance, and the positions in HICL and INPP were exited during August and September. De Bunsen says the successful consortium bid for John Laing Infrastructure (JLIF), which completed at the end of September at a 23.6% premium to JLIF’s share price and a 19.8% premium to its NAV, underlines the attractiveness of the sector, and may have provided further demand for shares in the remaining peers such as INPP and HICL, as JLIF’s shareholders looked to reinvest the proceeds of the sale.

HAST aims to achieve NAV total returns of c 8% a year over rolling three-year periods and, over three years to end-November 2018, has returned 8.3% a year (share price total return of 9.7% pa). The lower returns of c 3–4% pa over five years and since the trust moved to Janus Henderson in April 2013 (Exhibit 5) reflect the time it took for HAST’s managers carefully to reconstruct the portfolio. Conditions across asset markets in 2018 have been more challenging than in recent years, and HAST’s managers are pleased that the portfolio (as measured by NAV performance) proved relatively resilient in the equity market volatility seen in the first half of the year and more recently. They point out that c 90% of the sterling return of the FTSE World index in the first eight months of 2018 came from the US equity market, principally in technology stocks, an area where HAST has very little mainstream exposure.

Significant positive contributors to performance so far this year include property developer/fund manager Sigma Capital Group, a new holding at the start of the year, whose shares have appreciated by 29% year-to-date (to 4 December) on the back of strong demand for shares of its fund, PRS REIT; and EF Realisation, sold to a third party seeking exposure to its largest holding Lonestar Resources, ahead of the end of the realisation period in September. The ripple effects of the US trade dispute with China and the strong US dollar have been negative for emerging markets (EM) in general, and HAST’s holdings in EM funds such as the Ashmore EM Local Currency bond fund, the Sloane Robinson Emerging Markets Equity fund, and the Indus Pacifichoice hedge fund all detracted from returns. Property was the best-performing sector in the portfolio during the October equity and bond market sell-off, with largest holding Ceiba Investments providing a positive return as a result of its listing on the Specialist Funds Segment of the London Stock Exchange. Although the shares listed at a 16% discount to net asset value, this was a smaller discount than the conservative 25% at which HAST had valued its holding, resulting in an uplift for the portfolio.

Having narrowed to a five-year low of 11.0% in early January 2018, HAST’s discount to cum-income NAV has widened as equity markets have seen more volatility throughout the year, and stood at 19.3% at 5 December (based on the 30 November NAV). This is wider than the average discounts over one, three, five and 10 years, which range from 16.6% to 17.2%. HAST’s managers say the discount narrowed prior to January’s successful continuation vote and widened thereafter, which is not uncommon, although they add that the generally wider-than-average discount (the average of close peers is a premium of 1.1%, and the average discount for all investment trusts is 4.0%) may reflect a market perception that HAST holds more illiquid assets than is actually the case. Over three years, HAST has also outperformed the majority of peers in NAV terms.

Structured as a conventional investment trust with one class of share, HAST had 38.7m ordinary shares in issue at 5 December 2018. The board has the authority to buy back up to 14.99% of shares or allot shares up to the equivalent of 5% of the share capital, in order to manage a discount or a premium. However, there is currently no formal discount control mechanism. Gearing is permitted up to 20% of net assets, but HAST currently has no borrowing facilities, as underlying holdings may be geared and the managers do not wish to add an extra layer of risk to the portfolio.

In February 2018, the board of HAST announced a reduction in the management fee it pays to Janus Henderson Investors. Instead of a flat 0.70% of net assets per year, the manager now receives 0.60% pa on net assets up to £250m (currently c £130m), falling to 0.55% pa on net assets above £250m. This means ongoing charges (1.02% in FY17) could be lower for FY18/19.

HAST follows a progressive dividend policy and has grown its annual pay-out significantly since the change of management group in 2013 (compound annual growth of 33% from FY13 to FY17). Dividends have historically been paid annually in February/March, and for FY17 (paid February 2018) amounted to 4.75p per share. The board points to the higher level of income generated by HAST’s restructured investment portfolio as an important support for future dividend growth. Following the change in year end from 30 September to 31 March, HAST indicated that two dividends will be paid in respect of the transitional period from 1 October 2017 to 31 March 2019 (FY18/19). An interim dividend of 5.0p per share will be paid on 31 January 2019 (broadly in line with the previous full-year dividend schedule) covering the period from 1 October 2017 to 30 September 2018, with a further dividend for the final six months of the period (from 1 October 2018 to 31 March 2019) to be paid following the 2019 AGM, which will move from January to July as a result of the change in year end. The board has indicated that, in future years, a single annual dividend will be paid in July. Based on the current share price and the H118/19 dividend, HAST has a dividend yield of 1.8%. At 31 March 2018, HAST had revenue reserves of 7.2p per share, equivalent to 1.5x the FY17 dividend.

The Association of Investment Companies’ Flexible Investment sector is home to 16 funds (some of which have multiple share classes) that fall broadly into the categories of multi-asset, fund of funds or absolute return. The funds have widely differing mandates, leading to a similarly wide range of performance outcomes. Below we show a group of peers that we believe to be among the most comparable to HAST, as well as including the average figures for the whole sector. HAST’s NAV total returns are above the peer group average over one and three years and below average over five years, ranking second, third and sixth of eight funds, respectively. Ongoing charges are below average and there is no performance fee. HAST’s 18.4% discount to NAV is wider than the average for the whole peer group (although several funds trade at discounts of more than 25%) and is significantly wider than the average of the close peers (which trade at a discount of 1.3% including HAST, or at a premium of 1.1% excluding it). The managers point out that in light of HAST’s improved medium-term performance record, both in absolute terms and versus the close peers, its wide discount could be viewed as anomalous. In common with the majority of peers, HAST is ungeared; however, some of its underlying holdings may use gearing. The dividend yield of 1.8% is below the average for the whole sector, but in line with the close peer group average.

There are four directors on HAST’s board, all non-executive and independent of the manager. Richard Gubbins was appointed in July 2014 and became chairman later the same year. Jamie Korner, the senior independent director, joined the board in 2013, while Graham Oldroyd, chairman of the audit committee, became a director in 2014. The newest director is Mary-Anne McIntyre, who was appointed in September 2017. The directors have professional backgrounds in accountancy, law, and investment management.