Sequoia Economic Infrastructure Income
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Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Sequoia Economic Infrastructure Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research. Kepler.
SEQI offers a yield of almost 9% without the use of gearing…
Overview
Sequoia Economic Infrastructure Income (SEQI) offers exposure to infrastructure assets. The trust invests in debt, meaning that its investments are higher up the capital structure than equity and therefore more secure in the case of financial difficulty. These are private, off-market deals, which helps the specialist team managing the portfolio to generate a very high yield for investors, without the use of gearing. SEQI’s historic yield is 8.9% at the time of writing
SEQI is managed by a team of private infrastructure debt specialists, who have brought the asset class out of the banks and into the mainstream via the investment trust structure. Lending to infrastructure gives exposure to economically dynamic and vital trends such as digitalisation—via data centres, broadband networks, and telecom towers—and the greening of the grid—via renewable energy and investments in the network itself. SEQI’s portfolio is highly diversified across industries, with a focus on defensive sectors, as we discuss Portfolio.
In recent months, investment activity has included investments in digitalisation and the broadband network, and the managers report they are continuing to look for ways to invest in ESG-friendly sectors such as renewables. Activity has included a loan to finance the construction of a power plant located next to a Microsoft data centre in Ireland.
NAV performance has been stable, and dividends achieved high, with very few non-performing loans. Good progress has been made recently, and the exposure to NPLs is just 3.7%. Nonetheless, in keeping with the broader investment trust sector, the Discount has remained wide and sits at 19% at the time of writing. The board has embarked on one of the most extensive buyback programmes in the sector to boost shareholder value.
Analyst’s View
It is easy to get lost in the details of a private debt portfolio, but at its core, it is a relatively simple model. Companies that can’t or don’t want to access the public debt markets borrow money from specialist teams of lenders who have the knowledge and resources to do all the underwriting work and the research necessary to satisfy themselves about the creditworthiness of the borrower. The lenders earn a higher yield for doing that work (and saving borrowers the costs of raising public debt) and for the illiquidity of the private debt.
This illiquidity means that trading is not a major part of the model like a traditional bond fund. The management team, led by Steve Cook, make loans for three to five years with the aim of holding to maturity. Companies will prefer to raise money this way if they are raising small amounts of debt or if they operate in specialist areas or want bespoke conditions in the deals – Steve and his team, with many years of experience originating this debt in investment banks, are able to assess the risks and do the analysis required to make these deals work .
We think the main benefit from an investor’s point of view, is the high yield, which can be achieved without the use of Gearing and without the volatility in the value of the investments. Most of the trusts which offer yields that compare to SEQI’s, do so by gearing up extensively, bringing costs and volatility. Similarly, short-dated loans, roughly 40-50% floating rate at any one time, are less volatile with regard to valuation than publicly traded debt, which will typically have a higher duration. SEQI pays to have its portfolio revalued each month by an external party, PWC, which should reduce any concerns the value is stale.
As an investment trust, there is, however, potential volatility in the shares, and a wide Discount has opened up. The board is committed to returning substantial amounts of capital via buybacks, which should provide some comfort, but in our view interest rate cuts are likely to be the cause of a sustained shift in the rating.
Bull
A high dividend yield from a portfolio with relatively low credit risk
Highly diversified exposure to a specialist asset class via an experienced team
Significant buyback programme offers additional source of NAV return and demonstrates conviction in portfolio
Bear
Unfamiliar asset class for many investors
Yield on floating rate portion of portfolio may fall with interest rates
As a credit fund, only modest NAV upside expected
