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Questor: a 5pc yield from a cautiously managed trust? Welcome to ‘infrastructure debt’
Questor investment trust bargain: these little-known assets require specialist handling but defaults are rare despite the generous income and there’s scope for capital gains on top
It's not often that you come across a part of the financial markets that’s worth trillions of dollars but largely unknown. However, the assets held by this week’s trust fit that description, for the infrastructure debt market is as large as it is overlooked.
In an area that requires specialist skills, Sequoia Economic Infrastructure Income can call on the team of experienced professionals at its management company, which shares the Sequoia name.
What do we mean by infrastructure debt? Structures such as bridges or facilities such as airports can be enormously expensive to build and the organisations behind them typically need to borrow the money required.
Sometimes it is raised by issuing conventional bonds but much of the funding needed comes from “face-to-face”-style agreements. In effect, this involves a fund lending directly to the owner of the infrastructure, much as a bank might lend to a business. Unlike with bond issuance, there is no tradable instrument.
This means of raising money plays to the Sequoia managers’ strengths because they have the relationships needed to establish contact with the borrowers and the skills to assess the likely risks and rewards of each loan.
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James Klempster of Momentum Global Investment Management, who has a stake in the Sequoia fund via his own Focus portfolios, said its managers typically had decades of experience in relevant roles at investment banks, asset managers or credit rating agencies and had known each other for similarly long periods.
“You need managers who are good at researching the debt instrument itself as well as the underlying asset – the bridge or whatever it is,” Mr Klempster said. “The Sequoia managers have these skills but they are also cautious, which we like: they reject 90pc of the deals they are offered.” He said the fund had not suffered any defaults even though the interest rate on its loans averaged 8.6p.
“In the infrastructure debt sector there tend to be few defaults because there is normally fairly good certainty over the cashflows from the assets concerned and because the debts are normally high in the capital structure, meaning that the lender would have a good claim on any assets,” he added.
“The yields of 8pc or so are more to do with the specialist nature of the assets and their illiquidity.”
The trust itself yields 5.3pc – the difference is due to its costs, retention of some earnings and its current premium – but it also offers some scope for capital gain, with a target of about 2pc a year. Mr Klempster said: “Although there is no ready-made market in which to sell unlisted debt, opportunities do occasionally arise. However, you need those specialist skills and contacts to trade this kind of asset.” Otherwise the loans are held until maturity.
Another useful aspect of the loans Sequoia makes is that they tend to be “floating rate”: the interest rate is tied to a benchmark, such as Libor, so there is scope to earn more if interest rates generally increase.
The fund’s managers boast of running a low-cost operation and the portfolio’s annual cost bears this out – at 1.04pc it is relatively low for such specialist assets. The fund makes limited use of gearing because it tends to pay off any short-term borrowings with the proceeds of share issues.
“Many countries have under-invested in infrastructure recently so this market should grow strongly in the next decade or so,” Mr Klempster said. “This is a trust we can see ourselves holding for a while and we intend to take part in future share issues.”
Questor says: buy
Ticker: SEQI
Share price at close: 114p
Update: Woodford Patient Capital Trust
We have covered this fund extensively so will confine ourselves to noting its intention to appoint Schroders as the new manager and to maintain our avoid stance, with a preference for Syncona.
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