RM Funds: Targeting long term, stable and predictable returns
Chief Investment Officer James Robson explains how RM Funds use lower risk real estate, infrastructure & alternative lending investments to generate steady income, protect capital and offer modest capital growth
Alternative investments have been a popular area of focus for both retail and institutional investors over recent years. Alternatives have become standard jargon – yet one could be forgiven for not knowing exactly what is meant by the phrase ‘alternative investments’.
Alternative investments may range from higher risk higher return hedge fund, commodity and private equity strategies through the risk spectrum to lower risk infrastructure, alternative lending and real estate strategies.
They are not typical fixed income (bonds) or equity investments, meaning returns should have little correlation to the high equity valuations and low bonds yields which are a consequence of the post financial crisis quantitative easing and the low discount rates used for asset valuations.
‘returns should have little correlation to the high equity valuations and low bonds yields’
At RM Funds we have built a team around alternatives with a focus on lower risk investments that generate steady income, protect capital and offer modest capital growth.
RM has advised on a variety of alternative asset transactions and manages two strategies within this space.
The first is a London listed investment trust, RM Secured Direct Lending and the second strategy is a UCITS product called VT RM Alternative Income; these strategies target an income distribution of 6.5% and 5% respectively.
These steady bond-like returns look attractive when compared to traditional fixed income products available to investors.
One of the larger traditional fixed income products is the iShares Corporate Bond UCITS ETF with a yield to maturity of 2.84% and duration of eight years. Here to my mind the prospect of capital losses in excess of the annual income is very real.
As interest rates rise, bond fixed prices fall, and such a duration and low yield exposes any investor to capital losses with relatively little income as compensation.
The significant returns seen across the corporate bond market seen post financial crisis as risk free yields plummeted, combined with additional returns as spreads compressed due to QE are behind us.
The risks are that global yields start to rise and the great rotation out of fixed income occurs, thus putting pressure on traditional fixed income product prices.
Alternatives are an attractive option to consider for their portfolios however investors should be aware of the following structural investment risks and ask these questions:
- Liquidity: Unless you are a pension fund or a significant institution why would you not want to be in a regulated and liquid structure?
- Disclosure: A lack of liquidity usually comes with low levels of disclosure. Transparency has been a buzz word for some time but is still lacking in many investment opportunities. A recent FT article commented on Lendy, the peer to peer business which reported a 12.3% non-performing loan book. However, FT analysis showed 62% of the loan book was outside its terms, meaning payments were at least one day overdue, begging the question – is there adequate disclosure here on the underlying portfolio performance? Investors need to know where exactly their investment is and what the ownership structure or security is, particularly when it comes to investments via platforms or mini bonds. Here the devil is in the detail.
- Assumptions: Nearly every investment requires assumptions to be tested; for example renewable energy investments sound safe and boring but changes in assumed future power prices can make large differences to asset values today or what assumptions might an alternative lender use around default rates and are these likely? Some tweaks in assumptions here, and movements there, have larger effects on values than others; the key risk is in identifying the big drivers of potential NAV changes and stress testing assumptions.
- Leverage: Put simply, one should not just look at the rate of return on an investment but the leverage required to achieve that return; if one business is using more leverage then there are additional risks – and that should mean an additional return. Investors’ eyes are usually drawn to the headline return rates.
- Valuations: Mark to market or mark to model? Is there an independent valuation agent as well giving additional investor oversight which investors can take comfort from. All RM funds have an independent valuation performed daily or monthly.
- Premiums/discounts to NAV: Listed investments can trade at a premium or a discount to published NAVs – this can provide an additional level of volatility even though the underlying portfolio value might be static.
RM Funds developed the VT Alternative Income Fund around three key defensive areas of the alternatives universe namely Infrastructure, Specialist Real Estate and Alternative Credit.
The focus is on infrastructure assets with long-economic lives that are essential to society such as schools, hospitals, and airports -cash flows are contracted and typically inflation-linked.
‘an area where the RM investment team have an edge, as experts in the areas of alternatives’
Specialist Real Estate can cover a range of more specialist or esoteric real estate which is less exposed to the business cycle. At RM, we focus on two key thematic areas – ageing populations and technological change, and typically invest in assets such as care homes, GP surgeries, and distribution centres, data centres.
Alternative Credit encompasses all non-bank lending activities from, direct lending, asset finance & leasing and structured credit.
When we construct our portfolio, we start with a top down analysis of the business areas where our focus lies. At this point our attention moves to negative screening against ethical guidelines – we then move through to specific bottom up company analysis – an area where the RM investment team have an edge, as experts in the areas of alternatives.
At this point should we wish to invest we need review the technical considerations – is there enough liquidity in the stock we are reviewing; what is the price volatility like. How is it trading versus NAV?
In excess of a 5% premium generally are screened out with an objective to have the overall portfolio not trading at a significant premium to NAV. Post investment the work does not stop as we move into the monitoring of the investment.
Within VT RM Alternative Income the objective is capital preservation and to generate an annualised income of 5%, with quarterly distributions and limited volatility.
‘Don’t brag about your lightening pace, for Slow and Steady won the race’
There are in excess of 45 companies currently in the portfolio with security or ownership across thousands of physical assets thereby offering downside protection as well as investor liquidity.
Disclosure is excellent with a complete portfolio breakdown show on each monthly factsheet; all direct fees to the manager are disclosed to the investor and indeed are capped. Price valuation at the portfolio level is done externally on a daily basis offering daily liquidity for investors. The fund is available for investment via most investment platforms.
People will always look to reach for higher returns and perhaps forget the liquidity or governance, but as in the real story of the Tortoise and the Hare, like the Hare I remind myself ‘Don’t brag about your lightening pace, for Slow and Steady won the race’.