The takeover of Round Hill Music Royalty Fund (LSE:RHMP, OTC:RHILF) is likely to be followed by more M&A activity in the sector, according to a new analysis of investment trust discounts.
Round Hill is one of what are called 'alternative' investment trusts, in contrast to their 'conventional' cousins that invested in listed equities.
The music investment fund's takeover at a 67% premium in the US$469 million take-private offer from Concord highlights that that the alternative portion of the sector "oversold" compared to the conventional trusts, according to analysts at broker Stifel.
A note from the broker on Wednesday drew attention to the significant differential in the NAV discount between alternative and conventional closed-ended funds, with a reversal from the trend that has stood since the 2007-8 financial crisis until a year ago.
Over the past year the sector discount has derated, almost entirely driven by the de-rating of alternative funds, Stifel's William Crighton noted, with these funds falling from an average discount of 8% to 23%.
In contrast, he noted, the average discount of conventional equity trusts is only slightly worse than it was 12 months ago.
"While clearly alternatives come with extra risks such as portfolio valuation, asset liquidity and often higher leverage, in our view the extreme and historically unusual disconnect highlights the oversold nature of the alternatives space," Crighton said.
Trend reversal
Since interest rates collapsed to near zero in the wake of the global financial crisis, 'alts' trusts have generally traded at a tighter discount than conventionals, and at a premium in recent years.
The current conventionals’ average discount of 12% is only one percentage point wider than at this time a year ago, the analyst noted, while the average historical discount of the alt sectors has substantially widened from 8% to 23%, with the sudden relative derating compared to conventional happening in September 2022 as gilt yields rose sharply.
Income-focused funds such as infrastructure, renewables, debt, leasing and royalties are estimated by the Stifel team to make up around 60% of the alternatives space, and have been particularly affected as their dividend yields became relatively less attractive.
Renewables trusts, for example, have derated by 28 percentage points and infrastructure by 24pp over the past year, data from the broker showed.
"Share prices also fell in expectation that higher yields would feed into higher discount rates and reduce valuations.
"In contrast, conventionals held up much better in discount terms, reflecting the visibility on daily NAVs, the use of lower leverage and less of a focus on yield."