An update from managers Nalaka De Silva and Jennifer Mernagh
In this podcast we are joined by Nalaka De Silva and Jennifer Mernagh, managers of Aberdeen Diversified Income and Growth Trust. Here they discuss the Trust's strategy, positioning and its evolution over the past six months. They also explore the outlook for the year ahead and describe the opportunities they are currently seeing.
Recorded on 5 May 2021.
Cherry: Hello and welcome to this Aberdeen Standard Investment Trust podcast, I'm Cherry Reynard.
With me today is Nalaka De Silva manager on the Aberdeen Diversified Income and Growth Investment Trust also joining us today is Jennifer Mernagh who takes over from Tony Foster who's recently retired from the Trust. We're going to be talking about the strategy and current positioning, welcome both of you.
Nalaka, I wonder if you could talk about the Trust's evolution over the past six months, what was the background to the changes.
Nalaka: Hi Cherry, hi everyone. So yes, the Trust has gone through this period of evolution as part of a strategic review that was conducted last year and really that was done to do a number of things.
One is to adapt to the global marketplace, which is changing and the overall evolution of the, I guess the changes in market dynamics whether it be macro policy, global trade capital markets you know have been accelerated through Covid. And really what the board were looking for was to find the portfolio mix that was that was fit for purpose for the future and that was to really evolve the portfolio to give investors the broadest range of investment opportunity, providing that stable income and growth. And we've done that through a combination of asset allocation shifts as well as looking at an increased exposure to private markets and given the importance of income giving the Trust the best ability to generate a stable dividend yield over the future.
A big part of the asset allocation work was really around the new target and the performance target and as part of the discontinuation of Libor and the review of the performance target, a more simplified approach to return measurement was chosen, so a six percent return over a rolling five-year period and the majority of that target return to be generated by income - so around 60% of that to be generated by income.
And as I mentioned before, there was a shift to private markets and part of I guess my role in our team's ability to generate opportunities for the fund was to really look at investing in this big marketplace and we'll talk about that in some detail but really to look at high growth areas of the market through venture capital and private equity along with stable income generating areas such as infrastructure and private debt coupled with you know real estate and natural resources which will, you know, bring income and inflation characteristics.
And the last part of it was part of the de-leveraging strategy by the board which was established through the purchase of 73% of the bonds that were outstanding at that point in time, which were expensive at 6.25 percent, you know quite expensive in terms of cash flow and a decision by the board to buy those back.
And that allowed us to do a couple of things - one is to steady up the dividend stream so there's more cash flow being able to be distributed and it would de-lever the portfolio from a risk standpoint. So really about, you know, the foundations for generating income and growth along with that foundation for capital growth over the long-term generating the income through reliable sources, focusing on that performance target over the long term, increasing that private market exposure to give us a broad diversified portfolio across public and private and then ultimately reducing risk by deleveraging - so that was the task and what we've looked to achieve over the last six months.
Cherry: Looking at that private markets exposure in a bit more detail, can you talk about which areas you've chosen to increase and what you think that's going to bring to the portfolio?
Nalaka: Private markets is a big place and so really, we break them up into I guess two main category types. So real assets being sort of infrastructure, real estate and natural resources - essentially land based opportunities and then private capital being private equity and private credit or private debt. And these are essentially the financing of private companies both on the debt and the equity side at different stages of their evolution, so the areas that we've chosen to increase are really to continue working on the infrastructure program so investing in essential assets that support domestic and regional growth such as schools, roads, hospitals, transportation assets. We're looking at renewable energy, energy generation supply, along with communication assets and these should provide fairly stable non-cyclical attractive yields that are linked to inflation which is really important at the moment. So, we're focusing on that and then at the same time you know looking at diversifies across real estate and natural resources as well.
The private capital portfolio, we're really focusing on private credit so that's increasing the dividend yield potential of the portfolio by generating higher spreads for operating in, I guess, the private markets. And that's across a range of opportunities, whether it be senior loans, subordinated debt or specialty finance to companies or projects, and then we'll supplement through the growth side through private equity as well, so really if we look at the areas that we're focusing on the private side it's really about the strong income streams along with the long-term growth potential of private equity type assets
Cherry: Jennifer, can I bring you in here. Fixed Income has been a very tough area to invest in 2020, looking ahead to the rest of 2021 and beyond - do you think Fixed Income and credit can still provide an income?
Jennifer: Yes I do, listed Fixed Income and credit investments can provide a return because we're assuming some credit risks from different types of borrowers. Specifically, within this portfolio it's possible to access investments that are structured in such a way as to make the default lower than it would have ordinarily been while still gathering a good level of income. The company can invest in asset-backed securities and these offer a high yield with a lower expected default in comparison to similar rated corporate credit. So, these ABs as they're termed, issue a series of bonds with different credit ratings which are backed by pools of assets such as corporate loans, mortgages, credit card debt and the owners of the highest rated bonds are less likely to experience defaults but they receive slightly lower returns, whereas the owners of the lower rated bonds can benefit from higher potential returns - but are also first to experience losses when defaults occur.
But the complexity of these structures can also lead to mispricing and that's what we feel the company can take advantage of and has been able to generate a good income from these assets over time and intend to be able to do that in the future as well. Sticking with the area of credit the other place which we derive good yield from is emerging market sovereign debt, so this can be issued in both local currency and it can also be US denominated - so issued in US dollars - and in the Trust we look to dampen the volatility of returns in the local currency credit that we own, by hedging out some of the risk. When lending to emerging market countries, you are provided often with a high yield as these countries typically have higher levels of interest rates, given the higher risks than developed market countries. And whilst in the past it might have been fair to say that default risks were materially higher, we think that the evolution of central banks towards a more disciplined monetary policy, the development of local currency markets which means that countries are more in control of their debt servicing. Combined with China's economic might which is now on a par with that of the US, which makes emerging Asian countries more resilient and therefore default risk remains but is lower than it might have historically been, so that's another area where we feel that we can continue to generate good returns for shareholders
Cherry: And Jennifer the fund has exposure in the listed alternatives segment as well, could you explain a bit about that part of the portfolio as well and how they generate an income?
Jennifer: So yes, as you've pointed out the Trust invests in listed alternatives and that's a way to gain exposure to less liquid alternative assets in a liquid format. One of the most widely known examples is Real Estate Investment Trusts that we allow investors to access property assets such as social housing, private rented accommodation, supermarkets in a liquid format and these listed alternatives extend beyond real estate as well - so can also include in social and renewable infrastructure and more what we might call esoteric assets, such as music royalties, healthcare royalties, shipping marketplace lending.
And these investments can offer really attractive yields and also the potential for capital appreciation and importantly the income is derived, that's derived, from these investments - it's typically backed by assets that pay out a stream of cash flows and tend to be durable over time. But because they're listed these securities can often trade at a different level to the underlying net asset value of what's owned, so we are able to take advantage of those pricing discrepancies where we see them which also is an attractive feature
Cherry: Okay thanks and there is also some sort of conventional listed Equities in the portfolio, what does that look like - what's the makeup of that portfolio today?Jennifer: Oh sure, so yes we do have a relatively I suppose small allocation to listed Equities and I suppose everybody who's listening would know, you know, it's essentially just allowing you to gain access to kind of some growth exposure and you know having some exposure to listed Equities allows the company to continue to grow its assets and to try to maintain that solid base from which the dividend is delivered. And you've pointed out quite rightly that we've made some changes recently so I think people may know that there has been a significant delivery of both monetary and more importantly recently fiscal packages, particularly coming out of the US and what that means to us is that we see continued persistent economic growth over the next three years, so to have some exposure to more cyclical areas of the global equities market makes sense.
And what we've noticed is that we feel that the UK Equity market is particularly undervalued - some valuations in other areas have run up - but the UK looks attractive and is a cyclical market, so we've added some exposure there particularly to growth Equities but also balanced out by a kind of larger cap index exposure. And then on top of that we have a European infrastructure equity exposure where we see that's a kind of a mega trend that will continue because of policies that have been put in place by administrations around the world and then those exposures are layered on top of a broad market developed equity exposure.
Cherry: Great thanks and Nalaka, just to finish off with you. Could you talk a bit about your outlook for the year ahead any key risks? Do you see any particular opportunities?
Nalaka: I guess my view would be sort of cautiously optimistic I'd say, the um you know - we're relatively positive on the range of opportunities that ADIG will get the chance to invest in over the next 12 months and beyond, but we're not out of the woods in terms of Covid. The unpredictable nature of the virus and how it's developing and the vaccine rollouts as Jennifer mentioned, there's been a huge amount of stimulus in the US which is positive for capital markets, so that will result in I guess more liquidity in the market and therefore you know we're somewhat concerned about asset pricing and what that means sort of in the near term and potentially the inflation outlook over the longer term. So I guess there's a broad range of risks that we're focused on but in terms of trying to look at opportunities within that, those risks do create opportunities and I think we're definitely seeing the benefits of being able to allocate capital to the private markets where we can generate still strong yields and if we think about all of that stimulus that's being put into the US around infrastructure for example that's, that's being translated in other parts of the world so you know US, European, Australian markets are all investing heavily in infrastructure which we're, which we're exposed to so, that capital expenditure.
Our mix between developed and emerging markets, I think will constantly evolve as we look at sort of global trade and the dollar and what that means in terms of FX volatility now that ADIG does hedge the majority of its exposure so, we hopefully won't see any of that FX volatility come through the portfolio. So we will really be focused on creating these income streams and in doing that private credit, you know providing liquidity to high quality companies that have got good business models but perhaps have you know strained balance sheets is where we'd be taking some of these opportunities and as Jen mentioned earlier, the risk of defaults around some of these areas are reduced and therefore we can generate excess returns for that segment of the portfolio. So overall it's really going to be a careful deployment and pacing exercise over the next 12 to 18 months, looking very carefully at business models and business model resilience for what the underlying investments are doing and then measuring our cash flows quite carefully to make sure that we can provide that stable dividend yield into 2022 and 23 announcements.
Cherry: Great okay thank you Nalaka and Jennifer for your insights today. If listeners have any questions about the Trust please do get in touch with one of the team here or check the website on www.aberdeendiversified.co.uk and thank you to everyone for joining us.
An update from the manager, Nalaka De Silva
In this podcast we are joined by Nalaka De Silva, manager of Aberdeen Diversified Income and Growth Trust. Here he discusses the recent strategic review of the Trust and how the strategy will evolve going forward.
Recorded on 16 November 2020.
Discrete performance (%)
|LIBOR + 5.5%||5.8||6.3||6.2|
A Including current year revenue. Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: Aberdeen Asset Managers Limited, Lipper and Morningstar. Past performance is not a guide to future results.
Interviewer: Hello, and welcome to the latest in the Aberdeen Standard Investment Trust podcast series. With me today is Nalaka De Silva Head of Private Market solutions and manager on the Aberdeen Diversified Income and Growth trust. We're going to be talking about the recent strategic review of the trust and how the strategy will evolve going forward. Welcome Nalaka, could we start with a brief introduction to the strategy and what you're trying to achieve with it?
Nalaka: Oh, hi. Thank you very much for having me. So the Aberdeen Diversified Income and Growth, Investment Trust is really there to provide a stable income and capital appreciation through a globally diversified multi asset portfolio. And we try to do that by investing in a range of assets that are less correlated to equity markets to provide that stable income and long term growth potential.
Interviewer: The Board recently undertook a strategic review on the trust. Can you talk me through the announcement from a few weeks ago and what it sets out?
Nalaka: So as I mentioned, the strategic review is really there to do two things, one, as a portfolio that spans across public and private markets, look at how we can create a portfolio that's going to be resilient in fairly uncertain times. And as you know, we've been going through a fairly volatile time for markets, still waiting to see how the US elections pan out from a policy standpoint and whether Mr Biden takes over, the Coronavirus and vaccine and how , will this continue to evolve over time. And, as a result, a portfolio like ADIG how will it react to those types of conditions going forward? So the review itself was to do two things one, could we de-risk the portfolio in a time of volatility? And how do we position ourselves to provide that stable income and growth? That required us to do a couple of things. One is look at the long term asset allocation of the portfolio, and look at how we structure our investments going forward. And finally, how do we implement in the near term?
Interviewer: Okay, and you've recently come in as lead fund manager on trust? Can you give us some insight into your background and also on ASI’s Private Markets capability?
Nalaka: Sure, so I'm responsible for private market solutions and I work with a range of clients from insurance companies to pension funds to wealth managers in building multi asset private market portfolios. I sit on the management group of broader private markets business, which is currently about £65 billion in size, as a result of the merger between Aberdeen Asset Management & Standard Life investments our platform is one of the largest private market vehicles or businesses in Europe. We have exposure to private equity infrastructure, real estate, credit and natural resources. And there’s about 230 people on the private market sides and real estate sides, working out of 21 locations globally. It gives us a fantastic platform to be able to provide investment content and access to arrange really exciting opportunities for clients.
Interviewer: Okay, and you've mentioned about how the Strategy has evolved and that markets will form a significant part of it. Could you just discuss that in a bit more detail, you know, how you're allocating between the different areas and that sort of thing? Sure.
Nalaka: So I think it starts to talk about a bit about what we did on the asset allocation changes in terms of looking at the portfolio and how it was previously positioned. We had a lot of exposure to equities, to fixed income in emerging markets and asset backed security space and a range of opportunities in what we described as special opportunities or special ops, which included things like aviation financing, shipping, music royalties, as well as private market investments, including kind of infrastructure and private equity. And looking at the portfolio today, and where we want to take it going forward it was to try and reduce risk in the portfolio in the near term. So that's taking equity risk off the table, in terms of volatility, and perhaps looking at where the emerging market exposure was taking us longer term. So what we've done is to reduce the exposure to equities, from roughly about 17%, down to 10% of the portfolio, we've taken 31% of emerging market debt and fixed income securities down to about 25%. And we're replacing that with private equity, infrastructure, real estate and credit assets on the private market size, and where we are and leading the special opportunities roughly the same around sort of 20%. So that will give a more stable portfolio going forward because of low volatility on the public market side. And where we were trying to enhance the yield of the funds will be accessing areas within the private markets, such as private credit and infrastructure, which are very stable, and cashflow generating parts of the market, where the income streams are identifiable and resilient.
Interviewer: And how are you accessing those investments? Are you are you making direct investments or you take a portfolio approach.
Nalaka: So we're taking portfolio approach to the overall portfolio is divided up into four segments, equity, credit, alternative and private markets. And within that, we're using the depth and breadth of ASI capabilities. So we have a very strong multi asset solutions team and currently expand upon their investment program within fixed income equities and credit assets, and also the diversified alternatives group. And on the private market sides so as I mentioned before, it's a big platform, investing across private equity infrastructure, real estate, credit and natural resources. So when we look at investing, we first work out where we want to target investments which markets would segment and the process of portfolio construction that takes place. And then from an implementation standpoint, we'll work with each investment teams or deal teams to execute in any one particular marketplace. So we will take direct investments and private markets, as well as investing through funds.
Interviewer: Okay, and stable, resilient dividends have obviously been a key priorities for the trust. Can you explain a little bit about how you're going to achieve that as it while also growing the NAV?
Nalaka: Sure, so the income is really important components of the portfolio. And I think it's important to perhaps distinguish in terms of the private market holdings, where that income is going to come from, and we have touched on infrastructure before the infrastructure has been building up in the portfolio, both on the public side and on the private side for some time, and we will continue to build on the core, that's investing in essential infrastructure, that supports the regional and domestic economies, things like schools, hospitals, transportation assets, energy generation, communication assets, these type of investments that's throw off a of a yield, that's very stable, and also has some form of inflation linkage, which will be helpful over the long term, and will build around that portfolio. And so the next place that we look for yield is private credit, investing or lending to businesses, where there'd be senior loans or asset backed securities or securities that are secured on the back of physical assets, where there's a high degree of protection for investors in uncertain times. And because the yield that we get from private assets is slightly higher than we would get on public assets because of the liquidity, that can generate a higher yield in the portfolio without taking a whole lot more risk. We will also get the growth coming through longer term from investments in private equity, the development of real estate assets, we're investing in mixed use and residential property assets globally, we're invested in timber, and agriculture and farmland assets. And so the growth aspects of the portfolio will be complemented from a core satellites built on the foundation of I guess, credit and infrastructure, and then private equity, real estate and natural resources around that.
Interviewer: And presumably, investing in these types of assets, create and bring the kind of unique range of risks. Can you talk a little bit about how you're managing those risks, you know, the key you have in place to look at that?
Nalaka: We look at risks on number level? So when we talk about the public and the private aspects, we look at the liquidity risk around an asset how liquid is an asset and how quickly can we sell it at the time that we want to. For private markets, it's a bit different we look at private markets as a long term hold of assets and sometimes we take time to put money into the investment, it takes time to be drawn down. You know, if we're building an asset, the time taken to plan consents, finally constructed assets until it becomes operational or stabilised, you know, takes a few years. so what we do is we try to balance that liquidity risk across the portfolio by having a range of investments at different stages. We also look at the types of risk we're taking on in the portfolio. So if we look at infrastructure, for example, these things will be typically linked to some sort of government concession on the social infrastructure sizes, schools, hospitals, transport assets, other assets might be kind of economically focused. So we look at energy. But the types of investments that we're looking for is to find an identifiable stream of revenue, which then gets distributed back to the funds, and ultimately back out to investors. And so when we build up a profile of all of the different investment types, and we've got a range of diversified alternative income sources within ADIG, we have got the likes of shipping, but areas that are in music royalties, for example, which is rather interesting fields. We've got litigation finance, which is financing court cases, and all of these providing, a cash flow back to the fund. We've also got the more traditional types of fixed income, so investing in emerging market bonds, where these are loans to governments or corporates in developing countries around the world which pay a relatively high yield. And then we've also got some lifted securities, which are backed by physical assets, called asset backed securities. And that's invested with a range of managers from commercial mortgage backed securities all the way through to different types of instruments that pay out the yield. So as we add all of those income together, that's what will prop up our dividend reserves, which will ultimately be paid out through the progressive dividend policy by the board.
Interviewer: Great. I mean, one of the benefits of the trust is clearly that it allows investors to be invested in investments if they're unable to access themselves. And can you talk a bit about how the trust can act as a diversifying for client portfolios and, and also perhaps why that's particularly important today?
Nalaka: Absolutely, I think, typically getting into particularly private markets is difficult because, one, they're not perfectly divisible, you can't invest through shares and buy, 1% of a private company, or invest in an infrastructure projects on a global basis. So having a vehicle which allows a broader audience of investors to be able to access these types of projects, or companies or assets through fund or directly make the investment trusts a really valuable vehicle for that. So you get access to things that are just not available physically or structurally can be accessed in normal forms. And then from a diversification standpoint, the range of assets that ADIG has, is quite a unique in a way. So it covers the full span of public and private, we've got risk buckets that are designed to generate returns and different points of the cycle at different points in the market. We have equities to do that, in the near term with a bit of a tilt to smaller companies, which are generating higher growth, and a bit of the tilt to infrastructure as well. Then we've got our fixed income and credit portfolios, which is diversified across a broad basket of underlying assets, whether it be government bonds, corporate bonds, and an asset backed securities. And you've got this really interesting space of alternative risk premia, as we describe it. And what we're going to be doing there is we're going to be selling down our listed infrastructure as we take on more private infrastructure, but still take on very interesting opportunities in terms of the likes of litigation finance, the music royalties, and other income generative stream which are less correlated to the equity markets. And then this big basket of private markets that we hope to grow with the portfolio in time to, including infrastructure projects, as I mentioned, private credit and exciting investments in private companies through a diversified basket of venture capital, private equity, natural resources and real estate. And that that diversification provides stability at times when markets are volatile. So not all of those assets move in the same direction. And when the world is correlated around particular times of the market, like we saw that through COVID and in 2018 or during the trade war and tech rhetoric that was going around at that point in time, and what we expect is while we will have some volatility, we will have a much smoother ride having a high proportion into these less correlated assets.
Interviewer: Great, and then just finally, what benefits have you seen from the recent phone repurchase.
Nalaka: The bond repurchase was something that the bulls are willing looking to do to provide more flexibility at the corporate level. So by taking the bonds, which are going out to 2031, and we're actually relatively expensive in terms of interest rates at about 6.25%, when there was quite a big interest charge in the fund. So one its providing more of a buffer, or more capacity to be able to provide that stable dividend, because we're not paying that expensive rate of interest. And because if the board decides that they're going to do share buybacks, which is an important part of discount management, as an investment trust, having that leverage covenants in place made it very difficult to do that. So just provide them more flexibility in discount management control and providing the propensity for a progressive dividend.
Interviewer: Great. Okay, thank you so much for those updates. And thank you to our listeners for tuning in. More details on the trust can be found at www.aberdeendiversified.co.uk. And please do look out for future episodes.
This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments and products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Aberdeen Standard Investments. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns. Return projections are estimates and provide no guarantee of future results.