Aberdeen Diversified Income and Growth bailed out by narrowing discount

Aberdeen Diversified Income and Growth bailed out by narrowing discount – Aberdeen Diversified Income & Growth has published results for the year ended 30 September 2018. Over the period, the NAV rose 2.5% on a total return basis. Fortunately, however, the shares moved from a 3.1% discount to a 3.2% premium. The share price ended the year at 124.5p, compared to 120.5p at 30 September 2017, resulting in a total return to shareholders over the year of 7.9%. By way of comparison, LIBOR + 5.5% per annum (net of fees) – the company’s benchmark – was equivalent to a total return of 6.2% for the year under review. The FCA has announced that LIBOR will be phased out by 2021 and the manager is in the process of identifying an alternative measure, consistent with the underlying choice of LIBOR, following which the board will approach shareholders for approval of a resulting change to the investment objective.

Total dividends for the year were 5.24p per share, lower than the 5.89p per share paid in the prior year, reflecting the planned rebasing of dividends, as set out in the prospectus published in March 2017. For the year to 30 September 2019, the board currently intends to declare four quarterly dividends of 1.34 pence per share or 5.36p per share in total. This represents an increase of 2.3% and compares to consumer price inflation of 2.4% over the year ended 30 September 2018.

Extract from the managers’ report

Our holding in Aberdeen Global Smart Beta Low Volatility Global Equity Income Fund was a major contributor to the Company’s NAV performance over the year. This actively managed portfolio, which consists of over 200 holdings selected for their exposure to factors such as quality, financial strength and value, is well diversified by geography and by sector. 

As the name of the fund implies, our equity approach is designed to deliver a higher yield with lower volatility than a global equity benchmark. Over time, this approach is expected to deliver an attractive risk-adjusted exposure to equities. Indeed, over the first half of the reporting period, this proved to be the case but, as might be expected, during the stronger market conditions over the summer the fund lagged behind its benchmark.

Over the year as a whole, the fund delivered +11.8% compared to a benchmark return of +14.9% in sterling returns. Much of the underperformance stemmed from US equities and, in particular, the lack of exposure to very highly rated technology companies.

In private equity, we work closely with colleagues in the Aberdeen Standard Investments Private Equity team to identify attractive opportunities for the portfolio. They invest with a wide range of specialist managers and, to date, we have committed capital to three strategies identified by the team. Updates on these investments are given in the table below. Two of them have already returned capital to us. Maj Invest 4 was a notable contributor to performance over the period. It sold two businesses at substantial premiums to carrying value and, as a result, we received a distribution of £4.0m. Our stakes in the remaining investments in six businesses were valued at £3.0m at the latest quarterly valuation which means that we have earned a return of over 40% on our original investment of £4.9m. Half way through the financial year, we acquired holdings in a selection of funds managed by Harbourvest and Mesirow from an existing holder who wished to exit from private equity. These funds, which are approaching the end of their investment lives, have a focus on US private companies. The underlying portfolios are very widely diversified by strategy and in terms of industry. We receive a regular stream of distributions from these fund holdings as businesses are sold by the managers. Since we acquired these investments, £0.9m has been returned to us for redeployment in other investments. The initial investment was largely funded by the sale of Forward Partners, the UK-focussed venture capital fund, at a premium to the carrying value in the 30 September 2017 accounts.

Physical assets (property, infrastructure and real assets)

These asset classes are ideally suited to our investment approach in that they are long term in nature, offer attractive risk-adjusted returns and add considerably to portfolio diversification. The table gives a brief summary of progress made by each of the longer term investment funds as their managers identified suitable projects and we invested capital in line with the total commitment made to each fund. Given the timescales associated with bringing these investments to fruition, carrying values at 30 September 2018 are, in some cases, modestly behind the total amount invested to date. This partly reflects fees paid to the fund managers but, in the case of the Aberdeen European Residential Opportunities Fund, a small write down in one project was necessary following an increase in future development costs. Over time, we expect most of these long term investments to deliver double digit percentage annual returns, net of fees.

In infrastructure, we made a new long term investment in Aberdeen Global Infrastructure Partners II (“AGIP II”). As we noted in the Half-Yearly Report, this stake was acquired in a related party transaction from Aberdeen Asset Management PLC. The due diligence process included an independent third party review of the fund valuation. Our investment in AGIP II coincided with the completion and successful opening of the Perth Stadium in Australia. The stadium, which is being operated on behalf of the State Government in Western Australia for 25 years, has been written up in value by AGIP II following its completion. As a result, AGIP II has begun paying dividends to its investors.

In addition, the Board has approved commitments to new infrastructure funds managed by specialist teams within Aberdeen Standard Investments: €28.5m to SL Capital Infrastructure II, which will invest in economic infrastructure (utilities, transportation and energy) in Europe; and, $25m in Andean Social Infrastructure Fund I which will invest in social infrastructure projects in Latin America. These funds are respectively targeting net of fee returns to investors of 8-10% and 13-15% over periods of up to 15 years and 11 years. Both are expected to acquire their first projects shortly and have attractive deal pipelines.

While the longer term investments are building up their project portfolios, we also maintain exposure to these asset classes via investments in a number of closed end funds. Over the year, our specialist property funds and renewable infrastructure funds generally performed in line with expectations but our social infrastructure investments are worthy of further comment. During the first half of the reporting period, we took advantage of share price weakness caused by heightened political uncertainty to acquire new shareholdings in two social infrastructure funds, HICL Infrastructure and John Laing Infrastructure Fund (“JLIF”). The collapse of one of their service partners, Carillion, caused further share price weakness at the beginning of 2018 and, encouraged by reassuring feedback on the fundamental health of the sector from a variety of sources, we added to these holdings and also acquired a new position in 3i Infrastructure. During the summer, JLIF received a take-over approach from two private infrastructure funds and an agreed cash offer, at a 24% premium to the closing share price prior to the approach, was completed at the beginning of the new reporting period.

Fixed Income & Credit

With most developed market bonds and investment grade corporate bonds continuing to offer very low yields, we retain our preference for alternative forms of credit such as emerging market (“EM”) bonds, asset backed securities (“ABS”) and global loans. ABS and loans are floating rate in nature and performed well over the year to 30 September 2018 as the US Federal Reserve’s benchmark interest rate increased from 1.25% to 2.25%. By contrast, investor sentiment towards emerging market assets deteriorated sharply in the second half of the reporting period, primarily as a result of financial crises in Argentina and Turkey – the asset class was a notable drag on portfolio returns over the spring and summer.

As we have noted in previous updates, the economic fundamentals for a variety of emerging market countries remain positive. Our economists’ “heat map” of financial indicators across the emerging markets complex shows that most countries are in much better health than at the time of previous crises. For example, currencies are not generally over-valued and many countries’ debt levels are lower with less reliance on overseas currency funding. We retain our view that a diversified portfolio of local currency emerging market bonds offers an attractive yield over a medium term view. For example, Mexican 10 year bonds yielded over 8% at the period end. The table below updates our exposures to individual markets. During the period, we reduced our exposure to India, reflecting a steady pick up in its rate of inflation, driven, in part, by the rising oil price.

Currency exposure

As we have noted previously, our analysis shows that the funding currencies used to fund our EM weighting, which are often impacted adversely by any deterioration in the global economic outlook, can help offset the volatility associated with our EM bond position.

EM currency exposures are a key part of our expected return from the asset class.  For other assets, our policy on currency hedging is generally to hedge exposures back to sterling so that the portfolio NAV is not unduly impacted by fluctuations in currency values.  This is important for our globally diversified portfolio which has over 75% of its assets denominated in currencies other than sterling.  Our policy means that the portfolio did not benefit materially from sterling’s fall over the summer when Brexit uncertainty increased.  However, the portfolio NAV would be largely insulated from the adverse impact of a sharp rally in sterling on the announcement of a favourable agreement.  Towards the end of the period, we made a minor adjustment to our currency hedging policy: a portion of our US dollar assets is no longer hedged.  This means that we would benefit from any “flight to safety” towards the dollar associated with a pick-up in global political uncertainty. 

In ABS, TwentyFour Asset Backed Opportunities delivered a return of +5.3% over the period.   The fund has a focus on medium-risk securities underpinned by diverse portfolios of mortgages and corporate loans from UK and European borrowers.  The portfolio had a gross purchase yield of 5.3% at 30 September 2018.  Marble Point Loan Financing, a new addition to the portfolio during the year, is aiming to deliver a higher income yield to investors: 8% per annum initially, rising to 10%.  It is investing in a diversified portfolio of secured loans issued by over 300 US corporate borrowers.

Aberdeen Global Loans Fund performed in line with our expectations over the year to 30 September 2018.  Like some of our ABS investments, it provides an additional means to access US corporate loans.  Over the period, the premium on offer from US loans over Treasury bonds was squeezed by the increase in bond yields (mentioned earlier), prompting us to reduce our exposure to this asset class.

Other asset classes

This category includes a mix of different asset classes, mostly with return drivers which are not directly connected to financial market conditions. 

We made a substantial addition to our exposure to insurance linked securities (“ILS”) at the beginning of 2018 in order to take advantage of higher annual premiums being charged for catastrophe cover following record losses in 2017.  We invested £25.3m in a new holding, the Markel CATCo 2018 Fund, which has an investment term ending in December 2020.  This fund is not exposed to losses associated with 2017’s hurricanes, earthquakes, wild fires and other catastrophe events which totalled close to $150bn.  These events caused sharp share price falls in our existing ILS holdings at the end of 2017 and in the first half of 2018.  In May 2018, the board of Blue Capital Alternative Income Fund held a shareholder consultation on the future of the fund and decided to wind it up.  It delisted in July but remains in the portfolio as an unquoted holding.  Capital will be returned to shareholders over the next year or so as the fund’s existing insurance contracts expire. 

Insured losses for 2018 have been at lower levels than 2017, with the autumn storms Florence, Michael and Jebi (which struck the Carolinas, northern Florida and Japan respectively), now expected to total around $30bn.  However, after the financial year end, two wildfires in California, including the deadliest and most destructive ever seen, led to tens of fatalities and the destruction of over 20,000 buildings.  To put this into context, the largest previous single fire in October 2017 destroyed 5,600 structures and prior to that no fire had destroyed more than 3,000 properties.  Industry experts are predicting insured wildfire losses will likely be over $20bn. 

In November, Markel CATCo, the manager of two of our ILS investments, declared that these losses would have a “material impact” on our holding in the Markel CATCo 2018 Fund.  In line with the accounting policy on unlisted investments, the Company’s daily NAV announcements to the London Stock Exchange between 22 November 2018 and 24 December 2018 included an adjustment to the carrying value of this fund prior to the formal publication of the 2018 fund’s November NAV announcement. 

The loss to the portfolio associated with these events is clearly very disappointing.  Nevertheless, the asset class retains the potential to provide an attractive, diversifying return over the long term and also to contribute to portfolio income.  As with any investment, we have regularly reviewed our analysis of the risk / return potential and have also been in frequent communication with the managers and boards as part of that process.  As we have already noted, pricing is influenced by claims levels and 2019 is expected to see further increases over 2018.  As things stand, we believe that the case for investing in insurance linked securities remains a valid one. 

Elsewhere, we reduced our exposure to absolute return investments (by selling the “trend-following” investment, AQR Managed Futures after a strong period of positive performance in 2017).  These holdings combine exposure to a range of investment strategies which target positive returns over time.  However, their performance over shorter periods can be influenced – positively or negatively – by a range of factors including, for example, volatility in equity or foreign exchange markets.  Over the spring / summer of 2018, performance was adversely impacted by the pick-up in emerging market currencies and persistently low equity market volatility. 

Our special opportunities asset class includes investments in market place lending, aircraft leasing and healthcare royalties.  These performed broadly in line with our expectations over the period.  However, our commitment to a long term trade finance fund lapsed after the manager failed to secure suitable investments within the agreed time frame.  New long term opportunities in litigation finance and healthcare royalties were approved for inclusion in the portfolio after the end of the year under review.”

ADIG : Aberdeen Diversified Income and Growth bailed out by narrowing discount


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