Henderson Alternative Strategies Trust — Steady improvement from multi-asset specialist

As shown in Exhibit 2 below (left-hand chart), global equity market returns have dwarfed those from alternative asset classes over the past five years, but have exhibited significantly higher volatility. All-time highs seen in many equity indices so far in 2017 have been accompanied by high company valuation multiples. The table shows world and developed equity markets are trading at forward P/E ratios close to 10-year highs. Emerging market forward P/Es, while still above average, are well below historical highs. While the fact that markets are at high levels does not necessarily mean the next move will be downwards, against such a backdrop, investors may wish to consider the diversification benefits of non-equity assets and emerging rather than developed equity markets.

HAST has been managed by Janus Henderson Investors since April 2013. Launched in 1991 as Scottish Value Trust, initially under SVM Asset Management, the trust changed its name to SVM Global Fund in 2004 and became Henderson Value Trust on its move to the new manager, adopting its current name in 2015 to underscore its investment approach.

Under managers Ian Barrass and James de Bunsen, who run specialist and alternative mandates within Janus Henderson’s multi-asset team, HAST seeks to exceed long-term global equity returns by investing mainly in specialist and alternative asset funds that are good quality but are niche, complex, or hard to access. The trust aims to provide a ‘genuinely differentiated and diversifying source of return’. Having inherited the fund after a period of poor performance under the previous management, the managers spent three years reconstructing the portfolio into a high-conviction selection of 30-40 holdings drawn from five investment categories: specialist sector, specialist geography, private equity, hedge funds and property. A disciplined risk framework aims to ensure a broad spread across these categories. At least 75% of the portfolio is in core, long-term holdings, with up to 25% available for investment in short-term, tactical opportunities. The managers target return potential of 8-20% a year from each investment, with the aim of achieving overall annualised total returns of c 8% over rolling three-year periods.

HAST sits in the AIC’s Flexible Investment sector, and performance is measured with reference to the FTSE World index, as well as a composite benchmark of 75% developed market and 25% emerging market equities, broadly in line with the expected geographical split of the portfolio. While the trust is permitted to gear, it currently has no facility to do so, as the managers feel the extra layer of potential risk is unwarranted given the illiquid nature of some of the underlying holdings, and the fact that these may themselves be geared.

Manager James de Bunsen sees a degree of complacency in mainstream asset markets, with high levels of investor exposure to equities and bonds, even though equity valuations are well above long-term averages and bond yields are close to record lows. He argues that there is more value in the HAST portfolio than in markets at large, with private equity, financials, healthcare and energy being among the more attractive sectors currently. Meanwhile, HAST’s non-equity exposure and the allocation to hedge funds could provide a measure of support in the event of a market sell-off. Reflecting their more cautious view, the managers have trimmed exposure to some private equity funds whose discounts have narrowed, as well as some of the higher-octane credit funds, which could be vulnerable should sentiment change rapidly.

One of the key differentiators of HAST, says de Bunsen, is its focus on hard-to-access funds, which may close to new investment owing to capacity constraints (this includes three of the five hedge funds in the portfolio). However, there is also exposure to more liquid equity funds in specialist areas that individual investors may be less likely to own, such as healthcare (Worldwide Healthcare Trust1 and The Biotech Growth Trust1) and financials (Polar Capital Global Financials).

HAST’s managers, Ian Barrass and James de Bunsen, assisted by Peter Webster, are responsible for alternative strategies within Janus Henderson’s multi-asset team, which manages nearly £5bn of assets. The managers have more than 40 years’ experience in specialist and alternative assets, with Barrass having particular expertise in private equity, and de Bunsen in hedge funds.

The investment process for HAST broadly splits into three stages:

The managers aim for the eventual portfolio of 30-40 funds to beat longer-term global equity market returns while displaying a lower level of volatility, with the funds selected being those that individual investors would be unlikely or unable to access directly. Turnover is expected to be relatively low, while derivatives may be used for hedging or efficient portfolio management.

At the 31 March 2017 half-year end, 40 investments made up 99.9% of HAST’s portfolio, while the top 10 holdings at 30 June accounted for 44.3% of the total. The patient process of restructuring the portfolio inherited in 2013 has now concluded, with exits from legacy holdings such as EPE Special Opportunities, Oryx International Growth, Firebird Republics, Acheron Portfolio Corporation, South African Property Opportunities and Ludgate Environmental achieved so far in FY17.

In strategy terms (see Exhibit 3), the major changes from 31 March 2016 to 31 March 2017 were an increase in hedge fund exposure and a decrease in specialist geography (principally emerging markets). The limit for hedge fund exposure was raised from 20% to 30% at the January 2016 AGM, and the managers have made use of this increased flexibility, with 22% of the portfolio invested in hedge funds at 31 March 2017.

The largest strategy allocation is to specialist sector funds. This includes equity sector specialist funds including Polar Capital Global Financials, but is principally made up of specialist credit funds. A recent acquisition is Axiom European Financial Debt Fund, a UK-listed, French-managed fund that specialises in the subordinated bonds of European financial institutions. With banks needing to restructure their balance sheets under Basel III regulations, HAST’s managers say there are opportunities for specialist investors who can assess the quality of the many lines of debt and buy attractive assets trading below par value. The second-largest allocation is to private equity, where a recent purchase is the US healthcare and technology specialist fund Safeguard Scientifics.

Geographically, the trust has a skew towards Western Europe (32.9% of the portfolio), expressed through hedge funds such as BlackRock European Hedge Fund, German property (Summit Germany) and the abovementioned financial debt fund. As shown in Exhibit 4, there is a broad spread of underlying sector exposures.

While HAST’s strategy exposure to property was broadly unchanged over the 12 months to end-H117, there are now only two property funds in the portfolio. These are Cuban specialist Ceiba Investments and Summit Germany, both in the top 10 holdings at 30 June 2017. Private equity exposure has been trimmed a little, as discounts on listed private equity funds have narrowed; the largest exposure is now the specialist fund Riverstone Energy.

Having concluded the three-year process of reorganising the portfolio by the end of FY16, the changes are now beginning to come through in HAST’s performance numbers. Annualised total returns over all periods of one year and more shown in Exhibit 5 (right-hand chart) are now positive in both share price and NAV terms, and the three-year annualised NAV total return of 6.0% is heading towards the managers’ 8% target. Absolute returns have been very strong over one year, and the discount is now back below short- and longer-term averages.

Returns versus a range of indices (Exhibit 6) are still negative over most periods. However, it should be borne in mind that these are all equity indices, and as such do not reflect the significant non-equity allocations within the HAST portfolio, which could provide a source of support in the event of a stock market decline.

Contributors to the improved performance over the past year include Polar Capital Global Financials, which has benefited from the reflation trade that has seen investors return to the financials sector. HarbourVest Global Private Equity1 and Tetragon Financial Group1 also boosted returns, as did the small holding in direct private equity fund EPE Special Opportunities (now sold), whose share price and NAV are both up more than 100% over 12 months, following the successful IPO of its holding in lighting specialist Luceco. More recently, hedge funds have contributed positively to performance, with BlackRock European Hedge Fund bouncing back from a poor 2016, although Majedie Tortoise has suffered from its constitutionally cautious positioning as equity markets have remained buoyant. Selected funds in the property, smaller companies and renewables/environment areas had a minor negative influence in H117, although the aggregate impact of the top five negative contributors to NAV was -0.6%, compared with +2.4% for the top five positive contributors.

At 16 August 2017, HAST’s shares traded at a 13.2% discount to cum-income NAV. This is narrower than the averages over one, three and five years (16.8%, 18.0% and 17.2% respectively), but a little wider than the three-year low of 11.2% reached in March 2017. The board has historically managed the discount with tender offers rather than regular buybacks. However, having returned 20% of NAV to shareholders by this route since December 2014, there is now a greater focus on creating natural demand through improved performance and building awareness through marketing to both professional and retail investors.

Structured as a conventional investment trust, HAST has one class of share, with 38.7m ordinary shares in issue at 16 August 2017. This is 10% lower than a year ago, following a tender offer in January 2017. A continuation vote takes place every three years, with the next scheduled for the January 2018 AGM. HAST may gear up to 20% of net assets, but has no borrowings at present because many of the holdings are geared and the trust’s managers do not wish to add an extra layer of risk.

Henderson is paid an annual management fee of 0.7% of net assets (calculated quarterly), charged 10% to revenue and 90% to capital. There is no performance fee, and ongoing charges for FY16 were 0.89%. Fees on underlying investments are deducted from gross returns.

HAST pays dividends annually, in February/March. Since FY14, facilitated by the more income-generative nature of the reconstructed portfolio, it has followed a more progressive policy, aiming for year-on-year growth in the ordinary dividend. Dividends paid under the new policy grew at a compound annual rate of 7.3% from FY14 to FY16. As FY16 was an unusually strong year for portfolio income (net revenue return of 7.5p per share compared with 3.72p in FY15), a special dividend of 2.6p was also paid, bringing the total dividend to 6.4p per share. Based on the current share price and the total dividend for FY16, HAST currently yields 2.2%, while excluding the special dividend, the yield is 1.3%. HAST’s managers state that the portfolio should be able to sustain a yield of c 1.5-2.0% going forward.

Exhibit 8 below shows the AIC Flexible Investment sector, introduced at the start of 2016 to aid the comparison of investment companies that have the flexibility to invest in a range of asset classes. Recent strong performance has seen HAST rise to third place for NAV total returns over one year, well ahead of the group average. Reflecting the trust’s difficult history and the time taken to rebuild the portfolio, returns over three and five years are below average. Ongoing charges are among the lowest and there is no performance fee. In common with most of the peers, HAST is ungeared. In a sector where several trusts trade at a premium, HAST’s discount is towards the wider end. The diversity of the sector means some of the peers target capital growth and some seek income; HAST’s 1.3% ordinary dividend yield, while below average, is the sixth-highest in the group.

HAST has four directors, all non-executive and independent of the manager. Mary-Anne McIntyre will join the board as a fifth director on 1 September 2017. Richard Gubbins was appointed in July 2014 and became chairman in November 2014. Graham Fuller has served on the board since 2007 and is the senior independent director. Jamie Korner became a director in May 2013 and Graham Oldroyd was appointed in July 2014. The directors have backgrounds in investment management, accountancy and law.