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QD view – a sector in turmoil

a kayaker in rapids

Another week, another bout of corporate activity. Subject to shareholder approval, abrdn China is to be absorbed by Fidelity China Special Situations, and Troy Income and Growth will merge with STS Global Income and Growth. In addition, abrdn European Logistics Income announced a strategic review, Downing Renewables and Infrastructure Trust said that it would consider selling a slice of its Swedish hydropower business, and Digital 9 Infrastructure announced its plans for a sale of its Verne Global investment. The good news is that boards are being much more proactive in tackling discounts than at any time that I can remember. Every day, a swathe of funds is buying back shares (look out for our review of November, which should be out soon, but over £600m flowed out in October alone).

Mending broken China

abrdn China (ACIC) is only a couple of years old. It was reconstituted from a merger of Aberdeen Emerging Markets and Aberdeen New Thai.

The emerging markets fund fell victim to the aversion to funds of funds (that we hope will ease once the cost disclosure rules are reformed) and a share register that had become concentrated as a result.

New Thai began life in 1989, did not raise much money and although there were periods when it did quite well, it was never that large a fund. Inauspiciously, over 70% of New Thai’s shareholders tried to cash in their stake at the time of the merger but there was a 15% limit on the cash option. That suggested an overhang of ACIC shares from the start and was probably one reason why the discount remained stubbornly wide.

The other problem was the disappointment that followed the lifting of China’s COVID restrictions. There were big hopes (from myself included) that this would kindle a resurgent Chinese economy and stock market. Fortunately, I did not add to my Chinese exposure at the time – ACIC’s shares fell by 37% from the peak in February 2023 to an all-time low just before the Fidelity China (FCSS) deal was announced. FCSS’s shares have not done much better, they are off 30% from the peak. I feel like we are closer to the bottom for China and so, as mentioned on this week’s show, I have added modestly to my exposure, buying ACIC to end up with shares in FCSS.

Larger, more liquid fund

The Troy/STS Global deal makes sense in that the combination creates a larger and more liquid fund, offering about the same yield (there is a tiny hit to income for Troy shareholders) and, because the managers think that the UK is cheap, retains a sizeable exposure to UK equities (35% of the portfolio at end October 2023) despite moving to a global fund.

New strategic review

abrdn European Logistics Income (ASLI) is a fund that I like. We have been writing notes on it since it launched in 2017 (see our last one here). The investment thesis remains intact. Valuations have taken a hit since interest rates started to rise but we think that they are close to the bottom – if rates have peaked, as we suspect – we may even be at inflexion point. Its board is undertaking the strategic review in advance of a continuation vote due next year. One problem is a lack of dividend cover. Rents should be rising which will alleviate the problem, but the board has suggested that a dividend cut might be needed.

The obvious merger partner for ASLI is Tritax EuroBox. It will be announcing results next Tuesday, which will give us some up-to-date insight into the strength of the market.

DORE should not have to resort to selling exposure to its best asset

Downing Renewables and Infrastructure (DORE) has, as we outlined in our recent note, a great opportunity to enhance the returns that it is achieving on its Swedish hydropower portfolio. There are a few factors at play here which we set out in the note. Quite a bit of this can be achieved without too much capital expenditure, but the managers have an attractive pipeline of opportunities that have the potential to further accelerate the growth of DORE’s income and NAV. As long as they can get a fair price for selling a slice of the hydropower portfolio to a third party, the deal makes good sense. However, it seems daft that they are having to resort to this, the sooner discounts on renewables funds narrow and these funds are able to back attractive propositions with fresh equity, the better.

Picking up on this point, it was encouraging to see NextEnergy Solar’s success in selling its Hatherden asset last week – see our story here.

How did Digital 9 board overvalue Verne Global?

Then we have Digital 9 Infrastructure. The share price reaction to the announcement of the deal to sell Verne Global is no great surprise. How it could go from confirming an end-June valuation for the business of £480m with the publication of its interim accounts on 28 September, to accepting a maximum offer for the business of £456m, a substantial chunk of which will not be realised until 2027, is beyond me. It calls into question the valuation of the rest of the portfolio.

I think that, as its board embarks on a strategic review, there will be substantial pressure on it to adopt a strategy of managed winddown. However, shareholders face a long wait for their money and they will likely want someone other than the existing team managing the process.

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