Fiddich Review Centre
Alternative Investment

Investment trusts hold up as refinancing risks loom

  • With rates rising, investment trusts face a risk of higher borrowing costs eating into returns
  • We ask which sectors are affected, and how trusts have responded so far

Is the cure worse than the disease? Some might feel that way about central banks raising interest rates to tackle inflation: a sharp increase in the cost of borrowing has already caused pain in various parts of the UK economy, from a fixed income sell-off to the much greater expense of taking on a mortgage and the knock-on effect on renters.

Tighter monetary policy also puts pressure on investment trusts, which tend to use a good level of gearing as a source of extra cash to put to work. Having been able to borrow on the cheap in an era of historically low rates, closed-ended funds now face higher debt costs that could deal a blow to returns. That could have particular implications for trusts investing in illiquid assets, although so far many boards have been proactive in locking in deals before borrowing gets any more expensive.

 

Pain points

Any trust whose loan is set to mature now or in the not too distant future could potentially take a hit due to higher borrowing costs. But the those holding more illiquid assets are likely to feel it more keenly. Mick Gilligan, head of managed portfolio services for Killik & Co, notes that trusts investing in liquid assets such as equities can likely choose not to refinance and instead sell assets to pay off their existing debt if the new costs are prohibitive.

“It is more problematic for trusts that hold illiquid assets and have an upcoming refinancing,” he said. Investors who have fallen for the appeal of trusts in areas such as infrastructure and property would therefore do well to check just how pressing the need to refinance might be, how much debt a trust has and how the board is managing the issue.

QuotedData property analyst Richard Williams noted that the property sector had been “hugely affected” by the refinancing issue, with some pointing to the woes of Abrdn Property Income (API) as an example of what can go wrong. Last month the trust announced it had refinanced its debt, due to mature in April 2023, at what Williams described as “far inferior terms” by locking in a rate of 6.97 per cent versus the previous 2.77 per cent. “This almost doubles its debt costs and will take around 20 per cent off earnings,” Williams noted. He added that swap rates have come down notably since early October, suggesting API’s timing has cost it dearly.

And yet rates are still much higher than a few years ago when API’s loans were originally agreed. Elsewhere, trusts have generally been ahead of the curve: property funds such as AEW UK Reit (AEWU) and Warehouse Reit (WHR) unveiled refinancing efforts earlier this year, while Civitas Social Housing (CSH) recently said progress had been made in hedging the company’s loan book against rate rises, with a further announcement due as part of the trust’s upcoming half-year results. Sector giant Scottish Mortgage (SMT) and UK small- and mid-cap trust Mercantile (MRC) also refinanced or raised new debt this year before rates jumped. 

Gilligan said the market had been concerned about music royalties fund Hipgnosis Songs (SONG) on this front until the trust recently unveiled a new credit facility that runs for five years.

 

Alternative finance

Burned by excess leverage in the financial crash, managers of private equity trusts tend to be careful about the cost and levels of debt they take on. Other trusts in alternative asset classes have a similar approach, as many managers of ‘alternative’ trusts do appear to focus carefully on the issue of debt and how much it costs.

When it comes to the established infrastructure funds, BBGI Global Infrastructure (BBGI) discloses its sensitivity to refinancing, with the team refinancing various investments in the last year and estimating that a 1 per cent increase in its refinancing rate would trigger a fairly modest 0.6 per cent decline in portfolio net asset value. Rival HICL Infrastructure (HICL) aims to make sure investments with refinancing risk within two years represent less than a fifth of the portfolio, and at the end of March it had no investments with such risk.

The risk is nevertheless worth monitoring via investment trust annual reports and market updates, and Dan Cartridge, assistant fund manager at Hawksmoor, would point to property trusts having high loan-to-value (LTV) ratios as one possible red flag – although most of the funds he and his colleagues follow in this space have modest LTVs below the 30 per cent mark, having locked in relatively low debt costs already by refinancing or both.

One exception he identified was Regional Reit (RGL), where LTV comes to more than 40 per cent. But he added that the management team “has an excellent long-term track record including managing property through the global financial crisis”.

Find below all the features in our special issue celebrating investment trusts. 

Spotting the true discount bargains – Val Cipriani highlights investment trusts trading at a discount

Where the money has been flowing in a year of turmoil – Dave Baxter looks at how investment trusts have fared in raising funds this year

IC Income Portfolios – one year on – Dave Baxter reveals how our experts’ pick of income trusts has performed and what changes are being made

Around the world in eight investment trusts – Alex Newman runs our global investment trust stock screen to produce the best investment ideas for regional diversification

Gearing up and down – Val Cipriani reports on the big gearing movements in the investment trust world over the past year

The professional picks 2022 – Our panel of experts pick their preferred investment trusts for the year ahead

Investment trusts hold up as refinancing risk looms – The sector has largely timed refinancing right

Capital preservation with a personal touch – Personal Assets Trust provides an asset allocation case study for a tough bear market

How cheap is Scottish Mortgage? – Looking beyond the growth trust’s price tag

Investment trusts’ unlisted headache – Exposures to private companies have brought their share of problems

When discounts signal a new buying opportunity – Our investment trusts system bottomed early in 2009, will history repeat?

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