Charities are under increasing pressure to find alternative sources of income. Equity dividends are stretched; payments from fixed income and cash, for long the mainstays of their investment portfolios, are at near record lows; and then there is the return of inflation, which has made the search for income all the more urgent.
The challenge is to get income without spending too much. An obvious solution is the alternatives universe, but even here the risks are manifold. Some charities have dabbled in hedge funds, without success. A better option for many has been the real assets sector, in particular property and infrastructure. The benefits of property are well-known: the returns are based on rental income, offering diversification with relatively low volatility. The asset class does feature low liquidity and higher trading costs, but this is not a problem for long-term investors, such as charities and pension funds.
The main challenge is to diversify the investment portfolio and establish a long-term, stable and growing income stream. At Quilter Cheviot, we use a range of investments designed to provide diversification and to spread income risk. The funds are invested mainly in property and infrastructure, but also in other specialist investments such as renewables, aircraft leasing and mortgage finance. All come with different risk profiles, both to income and to capital, but typically pay incomes of around 3-8%.
Ground Rents Income Fund is a real estate investment trust (REIT), with a focus on achieving stable, long-term performance by investing in long-dated UK ground rents. Historically, these have not suffered the same peaks and troughs as the economy or even the wider property market. The fund has acquired sites across the UK, including most recently in Brentford, Bristol, Northumberland and the Vita Student Village in York. The ground rent income of all of these assets is linked to RPI.
Secure Income REIT has a portfolio of 81 well-established real estate assets. These include 19 private hospitals throughout England, with a rental income of £45.6m (as at December 2016). The rent increases by a minimum of 2.75% per annum each May throughout the lease term, which currently is 20.4 years with no break options. Also in the portfolio are four well-known visitor attractions, including Alton Towers and Thorpe Park. Rental income at December 2016 was £31.4m per annum, increasing annually in line with RPI. The average unexpired lease term is 25.5 years, with no break options.
Tritax Big Box REIT is the only REIT dedicated to investing in very large logistics warehouses in the UK, known as ‘Big Boxes’. The assets are let or pre-let to blue chip names, such as Marks & Spencer, Tesco, Amazon and Rolls Royce. The fund is targeting a net shareholder return of more than 9% a year, over the medium term.
We also invest in the Charities Property Fund and the Property Income Trust for Charities. These pooled property vehicles are designed to enable qualifying UK and EU charities to co-invest in UK property in a way that is tax efficient for capital and income. An added benefit is that when they acquire property they are exempt from Stamp Duty. The funds’ performance over five years is respectively 9.9% and 9.8%, with yields of 4.9% and 6.3%.
Continuing the diversification theme, we believe that student accommodation also represents a good investment. GCP Student Living invests in modern, purpose-built, private student residential accommodation and commercial properties in London, targeting attractive total returns and regular, sustainable, long-term dividends with RPI inflation-linked income characteristics. The average rental growth for the portfolio of standing assets for the 2016/17 academic year is 3.9%, while the blended net initial yield is 5.1%.
Another attractive area is in primary healthcare premises. Primary Health Properties specialises in properties leased to GP surgeries, government healthcare bodies and other healthcare users. With 90% of the rent roll funded by government bodies, this investment has the potential to deliver a stable income stream.
Infrastructure is popular with charities and pension funds for offering long-term flows of income. Quilter Cheviot invests in a range of specialist infrastructure funds. HICL Infrastructure has an investment strategy that focuses on assets positioned at the lower end of the risk-reward spectrum. The assets are located mainly in the UK, but also internationally. The investments have a cash yield of more than 4.5% for an average concession life of more than 20 years.
International Public Partnerships invests in schools, courthouses, police stations, rail operations and other assets in eight different countries. The portfolio has consistently delivered dividend growth and capital appreciation. A significant portion of the portfolio (10.9%) is invested in secured senior debt.
BBGI, a Luxembourg-incorporated company, has a geographically diversified portfolio of infrastructure assets with strong yield characteristics, based on government-backed revenue streams, inflation-linked returns and long-term contracts. Since being listed on the London Stock Exchange in December 2011, the company has delivered a total shareholder return of 73.8%, or a compound annual growth rate of 13%.
The government’s promotion of the renewables sector presents an investment opportunity. Bluefields Solar Income Fund offers 7% RPI inflation-linked returns, backed by contracts that the UK government is unlikely to pull for reputational reasons. But, with advances in technology, for example battery capacity, the sector can only grow.
Aircraft leasing is a niche investment strategy with interesting returns on investment. Doric Nimrod Air, a Guernsey-based company, manages three Airbus A-380 airplane investment companies, with planes leased to Emirates Airline, the government-backed national carrier of United Arab Emirates, operating out of Dubai. The fund aims to obtain income and capital returns by acquiring, leasing and then selling single aircraft. It offers an income of 8.25% for 12 years, which is hedged into sterling. The debt is amortised over 10 years, which gives the fund outright ownership of the aircraft for the last two. There is no guarantee of capital returns on the sale of a 12-year-old aircraft, but the risk is mitigated by the A-380’s construction quality and the fact that Emirates Airline operates long-haul routes, which are easier on a plane’s airframe than short-haul routes.
We believe a mixture of the above types of alternative investment can offer charities the ability to diversify income risk and potentially offer lower capital volatility, when investing for the medium to long term.
The value of investments, and the income from them, can go down as well as up. Investors may not recover what they invest.
Quilter Cheviot Limited is registered in England with number 01923571. Quilter Cheviot is a member of the London Stock Exchange and authorised and regulated by the UK Financial Conduct Authority.
William Reid is head of charities at Quilter Cheviot