Unless otherwise stated, returns are MSCI Indices expressed in local currency terms. The return for the UK equity market uses the FTSE All Share Index in local currency terms.
December was marked by an escalation in equity market volatility, particularly in the US and Japan, amid an ongoing slump in stock prices. Global stock markets declined over 7% in both US dollar and sterling terms with the frequently-observed December rally nowhere to be seen. At one point, both the S&P 500 and Topix indices had plunged 15% from their levels at the end of November. European, UK and emerging market equities were also lower.
Government bond yields moved lower (and prices rose) with the Japanese 10-year government bond and 8-year German bund yields dipping below zero. Credit spreads (the difference in yield versus equivalent government bonds) moved wider, particularly for high yield bonds. The moves in hard currency emerging market debt were less significant as yields declined slightly overall and emerging market currencies were little changed. Commodities were dragged lower by the continued decline in the oil price, although gold performed strongly.
At the US Federal Reserve (Fed) meeting, the central bank again raised interest rates by 0.25% but lowered guidance for the number of expected increases for 2019 to just two. In addition, the forecasted longer-term interest rate was lowered to 2.75%, the level to which 10-year US Treasury yields quickly moved. A partial US government shutdown followed later in the month as politicians failed to agree on funding.
The Italian government submitted a revised budget to the European Commission designed to try to avoid penalties for breaching European Union (EU) rules on government spending. In the UK, the government was forced to cancel a parliamentary vote on the withdrawal terms that it had negotiated with the EU due to insufficient support and Prime Minister Theresa May subsequently faced a party leadership confidence vote, which she won.
China took various actions to try to dissipate trade tensions with the US. Presidents Xi and Trump spoke towards the end of the month to continue the improved dialogue and hopes are increasing that a further round of tariff escalation can be avoided, reducing one of the significant risks to the global economy in 2019.
Over the month of October the fund’s Net Asset Value (NAV) lost 1.9% whilst the share price return was -3.0%. Over the same period the Company’s 11 Association of Investment Companies (AIC) Flexible Investment peer group returned -1.7% in share price terms (Source:Morningstar). The FTSE World Index, which the Company aims to outperform over the long-term, returned -7.0%. A relative outperformance of 4.0% in share price terms (Source:Bloomberg) and 5.1% in NAV terms. The Company finished the year with a NAV total return of -1.2%, ahead of the FTSE World Total Return of -3.1%.
The best performing sector during the month was the commodities sector. The BofAML commodity strategy rallied strongly during the period, returning 12.6% and contributing 0.5% to performance highlighting the benefit of having truly diversified exposure within a multi-asset portfolio.
The hedge fund and credit sectors proved very resilient during December’s volatility contributing -0.1% and -0.2% respectively. Within the hedge fund sleeve both the BlackRock European Hedge Fund and Sagil Latin American Opportunities Fund had strong months given poor equity market returns, returning 0.2% and 2.2% respectively. The Majedie Tortoise fund and Indus Pacifichoice funds fell during the month as oil prices fell and Asian equity markets performed poorly.
The small detraction from performance within the credit sector was driven by Axiom European Financial Debt, which fell 5.4% during the period. The fall was offset by small gains in both the Ashmore Short Duration and Local Currency funds as emerging debt markets were largely resilient to the volatility in December and aided by falling yields as the market re-priced Fed hike expectations.
The public equity sector detracted 1.1% from performance. The Fund’s exposure to more mainstream equity sectors hurt performance. Exposure to financials and healthcare positions detracted 1.0%. More positively the funds relatively new position in Burford Capital increased 14.1% during the period and contributed 0.2% to performance. Burford outlined its capital sources for further investment in December and highlighted that it had been successful in raising a new private fund and had also established a relationship on lucrative terms with a sovereign wealth fund.
Private equity positions detracted 1.0% during the period. The largest detractor was Riverstone Energy Ltd that was impacted by the sharp fall in the oil price. The stock fell 8.5% and detracted 0.3%. Princess Private Equity fell sharply, falling 15% and contributed -0.2%. Other listed private equity exposure was robust given the sharp falls in public markets. Safeguard Scientifics was buoyed by the announcement of another portfolio exit on very attractive terms in early December. Baring Vostok Core Shares and Harbourvest Global Private Equity performed well relatively, falling just 3.2% and 2.0% respectively in GBP terms. We are aware that investors may believe there is a lagged effect in the private equity sector to market performance. Below we discuss the majority of this exposure.
Review of less liquid areas of portfolio
Periodically we will look to provide an update on the less liquid areas of the portfolio. We are conscious that investors ascribe discounts to illiquid holdings and we are minded to keep this portion of the portfolio at a relatively low weight. We have an investment limit that restricts allocation to unlisted investments without redemption rights to no more than 20% of the portfolio at the time of investment. The portfolio liquidity profile is shown below, please note that these numbers focus purely on the portfolio and do not take into account cash balances.
The two more illiquid sectors of the portfolio are unlisted investments without redemption rights and listed investments on minor exchanges. All of the positions with a material weight in either of these sectors are listed below.
|Mantra Secondary Opportunities||Unlisted without redemption rights||7.1%|
|Baring Vostok Core||Listed minor exchange||4.1%|
|Renewable Energy & Environmental Infrastructure II||Unlisted without redemption rights||2.9%|
|Eurovestech||Listed minor exchange||2.0%|
|Amber Trust||Unlisted without redemption rights||1.2%|
|Century Capital||Unlisted without redemption rights||1.2%|
|Firebird Republics||Unlisted without redemption rights||1.0%|
|ASM Asia Recovery||Unlisted without redemption rights||0.7%|
Mantra Secondary Opportunities (“Mantra”)
Mantra is a secondary private equity fund that targets stakes in niche private equity funds. Mantra seeks to invest at steep discounts to NAV in mature funds that are expected to provide liquidity in the near-term. Investments tend to be sourced by the manager rather than being won in competitive processes and provide liquidity to limited partners looking to exit mature private equity fund holdings. Both of these are justifications for the discounts that Mantra has achieved on their investments.
Henderson Alternative Strategies Trust made a $10m commitment in 2015. Due to the nature of Mantra’s investment in mature underlying assets, the fund life was shorter, with a less-pronounced j-curve (short-term negative returns followed by gains in the later years) than typical limited partnership funds. The investment period finished on December 31st 2017 with 91% of commitments drawn. Mantra has performed strongly and to date we have received just over 50% of our drawn capital back in the form of distributions. The position is currently held at the June 2018 NAV, adjusted for distributions.
Baring Vostok Investments PCC Ltd Core (“Baring Vostok”)
Baring Vostok is a direct investor that focuses on investing in unlisted companies in Russia and the former Soviet Union. Baring Vostok is listed on the International Stock Exchange.
The investment case for Baring Vostok revolves around both the long-term track record and quality of the management team but also the quality of the underlying businesses. US sanctions on Russia have impacted Baring Vostok’s ability to exit positions but have provided the benefit of reducing competition. The Baring Vostok Core portfolio provides access to a number of high-growth businesses with low debt levels. Baring Vostok’s interim report at the end of June 2018 highlighted that almost 60% of the underlying portfolio is experiencing revenue growth in excess of 20%. We expect a strong NAV release for the year-end when these operational results are included in valuations. The year-end NAV has typically been released alongside the year-end report and accounts in April.
Baring Vostok has been impacted by lower oil price and a weaker ruble; the Russian conflict with Ukraine and US sanctions. Despite these headwinds, the underlying businesses continued to grow revenues in RUB terms even as the Russian economy went into recession. Baring Vostok used this distress to gain market share for many of their portfolio companies. Over the past three years to the end of December, Baring Vostok has returned 21% annualised.
Baring Vostok trades at a 20% discount to its net asset value. In May 2018, we reduced our position in Baring Vostok Core shares and were able to do so at our carrying value.
Renewable Energy & Environmental Infrastructure II (“REEIF II”)
In October 2013, Henderson Alternative Strategies Trust made a €7m commitment to REEIF II. REEIF II has an investment period that ends on the 10 September 2019. To date, REEIF II has drawn 67% of committed capital. Currently, REEIF II expects to call an additional 7% of commitments in Q1 2019.
The strategy of REEIF II is to acquire permitted renewable energy projects, oversee financing and construction, and to exit the projects once they are operational. The exit environment for such assets is supported by high demand for assets with long-term, stable cash flows from pension funds, insurance companies and infrastructure funds.
To date, performance of the fund has been disappointing with a net IRR of -9.1%. No distributions have taken place to date. We believe that the harvesting period of the fund should provide stronger returns as a number of assets transfer from commissioning to operational stage and are exited. We also expect initial returns of capital to take place relatively quickly after the fund enters its harvesting period.
Eurovestech has been a difficult investment for Henderson Alternative Strategies Trust. It is a position that was inherited in 2013 when we took over management of the fund. Despite being listed on an auction platform, liquidity for Eurovestech is poor. We own 19% of the business. Our only real hope of liquidity comes from the continued efforts of management to realise the underlying assets and return cash.
Despite the lack of liquidity in the position there are some reasons to be positive. We hold Eurovestech at the last auction price on Asset Match, which is currently 4p. The actual NAV of Eurovestech, as stated in the December 2017 report and accounts is 11.5p, so we hold the position at a 65% discount. A successful result, in terms of liquidity and performance, relies on the sale of the largest asset within Eurovestech, ITWP Acquisitions Limited (“Toluna”), which accounts for 70% of net assets. The business is performing well and Eurovestech is seeking an exit from the position via multiple avenues but this is made difficult by the fact that it is a minority shareholder, as well as the increased volatility in markets. If Toluna were to be exited at its December 2017 carrying value, then 8p per share would be generated, double Henderson Alternative Strategies Trust current carrying value.
Amber Trust is a private equity fund focused on the Baltics. Amber Trust has three remaining investments, each representing roughly one third of net assets. All three businesses are exploring exit opportunities. A recent call with the Manager confirmed that it is reasonable to expect the fund to complete its realisation process this year and that carrying values remain conservative.
Century Capital IV is another inherited position. The fund has performed well, generating a net IRR of 12.9% and 1.8x multiple on invested cash. Over the life of the fund $139.2m has been invested in nine portfolio companies, two remain. One investment represents circa 65% of net assets and the second roughly 35%.
Currently we expect the exit of the largest investment to take place in early 2019 with the second investment likely to be exited in 2020.
Firebird Republics was inherited when Janus Henderson took responsibility for managing the fund in 2013. Firebird Republics is dominated by one position in Aktobemunaigas, a Kazakh oil and gas company. The business is highly cash generative and yields circa 8% which provides significant distributions to Henderson Alternative Strategies Trust. Dividends fell during the oil price fall of 2014 and 2015 but have recovered strongly in 2017 and 2018. The management team believe that the reinstatement of a consistent cashflow stream is key in attracting buyers. Aktobemunaigas represents roughly 85% of net assets.
Hedge fund ASM Asia has performed well since inception, returning 9.7% annualised returns since March 2002 to the end of November 2017. ASM are now nearing the end of their liquidation process. There are two meaningful positions left as well as a number of smaller positions that the team are attempting to sell as a portfolio. We believe that the majority of remaining proceeds should be received in 2019.
Valuations improved significantly in the second half of 2018 as sentiment became more bearish. Tax cuts strongly boosted earnings and GDP growth in 2018 but we expect both to moderate in 2019. Whilst central banks may pause or delay tightening in the face of financial market volatility, we are conscious that they may be forced to hike if inflation begins to pick up due to tightening labour markets or the impact of the trade war. As market expectations of Fed interest rates fall and the US dollar weakens, we see potential for emerging markets to perform.
Whilst valuations have improved, this is normal for the late stages of a bull market. We believe that 2019 will be volatile due to the stage of the economic cycle, deteriorating liquidity caused by the end of quantitative easing and the impact of trade wars and Brexit. We believe the Fund is set up well to navigate this difficult environment: with exposure to uncorrelated strategies; proven hedge fund managers who generate value throughout the cycle; investments with strong growth dynamics that we believe can withstand a general slowdown; and sector exposure geared to performing late cycle.
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.
Bearish / Bear Market: A financial market in which the prices of securities are falling. A generally accepted definition is a fall of 20% or more in an index over at least a two-month period. The opposite of a bull market.
Bull Market: A financial market in which the prices of securities are rising, especially over a long time. The opposite of a bear market.
Gearing: A measure of a company’s leverage that shows how far its operations are funded by lenders versus shareholders. It is a measure of the debt level of a company. Within investment trusts it refers to how much money the trust borrows for investment purposes.
NAV: The total value of a fund's assets less its liabilities.
IRR (internal rate of return): Is a metric used in budgeting to estimate the profitability of potential investments.