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Aberdeen Diversified Income & Growth discount widens as NAV returns fall short of wider market

Aberdeen Diversified Income & Growth discount widens as NAV returns fall short of wider market – The flexible investment sector company, Aberdeen Diversified Income & Growth (ADIG) has posted annual results to 30 September 2019. While NAV total returns increased by 1.1%, the share price was down by (9%). Chairman, James M Long, noted: “Reflecting this performance against a backdrop of rising equity and bond markets, the company’s shares moved from a premium to NAV (with debt at fair value) of 3.2% to a discount of (7.6%).”

Managers Mike Brooks and Tony Foster, provided the following commentary on the asset classes ADIG’s invests in (all % of net figures at 30 September 2019):

Listed equity (% of net assets reduced from 22.0% to 20.3%)

“We expect listed equity returns to be lower than their long-term average. This is partly a function of subdued long-term economic growth expectations, but also due to cyclically-stretched profit margins, especially in the US.  However, we do have some concerns about the outlook for the business cycle.  While our base case is for the continuation of sluggish economic growth, there is a relatively high downside risk of a global recession.  Our forecasts are averages across scenarios so this downside risk skews our outlook over shorter term periods.  Overall, we forecast an average return of 3.5% per annum for sterling investors over the next five years and, during the period, we made a modest reduction in our exposure to equities.

For the first eight months of 2019, the background of sluggish economic growth and low / falling interest rates and bond yields was reflected in a sharp re-rating of “growth” equities.  Time will tell if the failed IPO of the short term office company, WeWork, has marked “peak growth” in the current market cycle.  With the valuation disparity between growth and value styles close to record levels, the recent rotation back in favour of value has benefitted the Smart Beta Low Volatility Global Equity Income Fund, which predominantly focusses on high quality, good value businesses.  Nevertheless, its underperformance during the growth-driven market of 2019 has been a noticeable drag on portfolio returns.  The fund’s largest holdings and sector / regional positions are noted below.”

Alternative asset classes (private equity% o net assets  broadly unchanged at 4.3%

“Our private equity holdings performed well during the period.  The Harbourvest and Mesirow private equity funds, which are selling down their remaining assets, benefitted from the buoyant market conditions.  In March 2018, we invested £6.3m to acquire stakes in these funds.  By the end of September 2019, we had received distributions of £2.6m and our remaining stakes had increased in value to £6.5m.  ASI’s Private Equity team, who identified this profitable opportunity for us, have recently launched a new fund, Aberdeen Standard Secondary Opportunities Fund IV (SOF IV), which allows us to access this strategy in a more diversified format as our existing exposures wind down.  The Board has approved a commitment of £20m to SOF IV.  In line with the policy on ASI funds of this type, there will be no additional fee charged on this investment. 

TrueNoord, the aircraft leasing business in which we own an equity stake, alongside the management team and other financial backers, continues to develop in line with our expectations.  We made a small incremental investment during the period and, in addition, the company raised equity capital from new investors and negotiated a new five year debt facility in order to fund its fleet expansion plans.  In early October, TrueNoord acquired six additional aircraft, leased to Republic Airways, its first deal in the United States.  This expands its fleet to 41 regional aircraft, leased to 14 airlines.  At the end of September, we had invested US$5.4m in TrueNoord and the carrying value of our investment, which takes account of the ongoing development of the company and the recent third party fundraising, was US$9.1m.”

Physical assets (property, infrastructure and real assets) % of net assets increased from 20.9% to 27.3%

“We made good progress in adding to the physical assets segment of the portfolio, achieved by investing into funds with underlying exposure to infrastructure, property, transport and farmland.

SL Capital Infrastructure II, an economic infrastructure fund which is targeting a net of fee return of 8 – 10% per annum, acquired stakes in two district heating systems in Finland and a liquid fuel storage business in Germany and Belgium.  After the period end, it acquired a solar energy portfolio in Poland and made an investment in railway rolling stock in the UK.  Including these last two investments, we have now invested around €25m from our commitment of €28.5m. Andean Social Infrastructure I, where we have a commitment of $25m, has yet to make its first investment but it is making good progress with a very strong pipeline of opportunities.  One of these, a South American roads project, has recently been signed but the deal will not reach its formal close until early in 2020.  Others are at the final stages of negotiation.  We have made an initial investment to cover establishment costs of the fund which is targeting a net of fee return of well over 10% per annum.  Thirdly, we took advantage of a placing of new shares from the listed fund, Tufton Oceanic Assets, which now owns a fleet of 17 commercial sea-going vessels.  Against a depressed shipping market background, Tufton is currently able to acquire vessels at a sizeable discount to their depreciated replacement cost, and, as a result, is targeting a medium term return of 12% per annum with an initial dividend yield of 7%. 

The positive performance contribution from our infrastructure holdings partly reflected investor demand for assets which are perceived to exhibit a low correlation to risk assets.  Among our listed investments, we took advantage of this demand to recycle capital from holdings which we felt were fully valued into those offering more attractive returns including Greencoat UK Wind and Sequoia Economic Infrastructure.” 

Fixed Income & Credit % of net assets increased from 46.9% to 48.3%

“Emerging market government bonds are a relatively attractive asset class – particularly the local currency variety.  Yields are high (typically 6% or more in the countries we find most attractive), especially relative to developed market bonds, offering strong income returns.  With one or two exceptions, the emerging market economies covered by standard local currency bond indices are in good shape with solid growth, controlled inflation and low government debt levels.  Currencies are on average near fair value which reduces currency risk.  We also reduce currency risk further by funding our exposure using a basket of globally sensitive currencies including the Australian dollar and Norwegian krone, as we have discussed in previous reports.

During the period under review, emerging market bonds performed well and the asset class was a strong contributor to portfolio performance.  The table below lists our major country exposures at 30 September 2019 in our sub-portfolio which is actively managed on our behalf by the ASI specialist team.  We took advantage of strong performance to lock in profits in a number of positions in order to fund investments elsewhere in the portfolio but, overall, are happy to maintain a high level of exposure to this asset class.

In corporate credit, our preference is for less familiar forms of credit which we expect will deliver higher risk-adjusted returns than investment grade corporate bonds.  For any given credit rating, asset backed securities (ABS) typically offer a higher risk premium of 2% or more than conventional credit investments.  There is a similar story for direct corporate lending, real estate lending and other forms of private credit.  Our credit-related investments – in funds investing in ABS and global loans – delivered attractive income returns over the period.  We made no changes to our largest exposure, TwentyFour Asset Backed Opportunities Fund, which has a portfolio of European mortgage and loan-related investments.  However, we did reduce our holding in the Aberdeen Global Loans fund, which offers exposure to a diversified portfolio of corporate loans, in order to fund other investments.”

 ADIG: Aberdeen Diversified Income & Growth discount widens as NAV returns fall short of wider market

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