INCOME Investment trusts wing their way into alternative asset classes as bank financing stays subdu

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One of the advantages that investment trusts have over open-ended funds is their managers are able to invest in a portfolio of assets without the worry of inflows and outflows affecting performance. This means the trust structure is ideal for less liquid asset classes.

In recent years we have seen a large number of launches with an income focus from more alternative asset classes.

One of the reasons for this has been the bank deleveraging story, where one avenue of financing for such deals has disappeared only for specialist investment vehicles to pick up some of the slack. The result has been that many investors are now able to access these asset classes that were previously beyond their reach.

In a world where there is little value in government bonds and concerns have arisen over the valuation of corporate bonds, these alternative classes could well be worth a look at and in recent months we have been building up this allocation in our portfolios.

Aircraft leasing

Doric Nimrod Air 3 is an aircraft leasing vehicle that, once fully invested, will lease four Airbus A380s to the Emirates airline.

The aircraft are bought with roughly two thirds debt and one third equity. This is fully amortised over the life of the lease, which matches the life of the trust. The initial investment of 100p is returned so long as each aircraft can be sold for about 45%-50% of its initial value.

The managers believe the re-sale value will in fact be higher than this and so there is scope for a capital gain to be made. In the meantime, shareholders receive a very attractive dividend yield of 8,25%, which is paid in sterling and set in stone as part of the lease.

The prime risk here is the event that Emirates goes bust. In this scenario, the mangers will have to look for alternative companies to tease the planes out to. with the risk being a different income rate might have to be negotiated as well the time spent to negotiate a new lease.

Asset-backed securities

We also backed the new issue of Twenty Four Income a couple of months ago.

The portfolio here is made up of UK and European asset-backed securities, such as residential and commercial mortgages, auto loans, credit cards and small and medium-sized enterprise business loans.

These are bonds backed by specific asset pools, where the coupons and principal have direct recourse to the assets. The management believe they can take advantage of the currently high yields available from good assets at distressed prices.

The targeted return is 7%-10% per annum, with a dividend yield of 6%. The portfolio is currently just under 50% invested in residential mortgage-backed securities, reflecting the size of that particular market, with another 30% in collateralised loan obligations.

Interestingly, investors have the opportunity for a 100% exit from their investment in year three of its life, should they choose.
We have also been adding to Real Estate Credit Investments preference shares.

The underlying portfolio here is made up of UK and German residential mortgage-backed securities and commercial mortgage-backed securities and senior loans.

The preference shares rank ahead of the ordinary shares in the capital structure of the vehicle and pay an 8% coupon until the end of their life in September 2017.

Their repayment at par is over 2.6x covered by the current assets but they still trade at only a small premium to par.

Although there is no scope for capital growth if we hold them until the end of their life, the yield return alone is attractive and should be pretty stable owing to their short-dated nature, regardless of fluctuations in the wider bond markets.

Find out more about Cheyne Capital.

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