The news that the Airbus A380 would stop production in 2021 got a fair amount of press coverage on Thursday. It also provided a timely reminder of the risks of investing in alternative asset funds.
I saw the Airbus story early in the morning but didn’t notice the knock-on effect it had on the various aircraft leasing investment trusts until much later in the day.
This Citywire article gives some good background information on the trusts affected while this BBC piece looks at why the A380 has struggled to find favour with airlines, despite its popularity with their customers.
By the close of trade, the share price damage was pretty extensive. Doric Nimrod Air 1 (DNA) and Amedeo Air 4 Plus (AA4) both fell by 10%. Doric Nimrod Air 2 (DNA2) and Doric Nimrod Air 3 (DNA3) by 8%.
These are all the kind of trusts where the share price barely budges from week to week. Double-digit falls aren’t meant to be part of the deal.
The residual problem
I must admit that I had never looked at these funds in much detail before, putting them in the ‘too hard’ box.
But these share price falls spurred me to take a peek and the basic premise behind them is actually relatively simple:
1) Raise a load of money from investors and a load more from various lenders.
2) Use this cash to buy a plane.
3) Lease this plane to a reputable airline.
4) Use the money received to pay interest and regular repayments for the loan, with the remainder used for dividends and the fund’s running expenses.
5) At the end of the lease, the loans should be paid off in the full. The aircraft will be fully owned and still worth a decent amount. Presumably, it is either sold or leased out again.
However, the net asset value of these funds is heavily dependent on what the aircraft will be worth when the current lease expires. That’s not easy to gauge for most of us, having no direct involvement in such a specialised industry.
It is concern about these residual values that seems to be behind the share price falls, rather than worries that there might be problems with the existing leases.
The one-asset fund
Let’s look at Doric Nimrod Air One, as it’s the oldest of these funds and it only owns one aircraft.
Yes, it’s an investment trust with just one asset, which I find somewhat astonishing (this may be why it’s not listed on the AIC website).
The subsequent aircraft leasing funds raised enough to buy several planes, usually of different types, although A380s seem to be the most popular model.
The accounting bit
The original Doric fund joined the market in 2010 and its plane was bought for just under $180m. The exchange rate then was $1.55 so the cost in the books is £114.5m.
It’s being depreciated down to its estimated residual value at the end of its 12-year lease to Emirates. As of 30 September 2018, this residual value was reckoned to be £63m, although the accounts note it was £80m a year earlier.
Oddly, the December 2018 factsheet, released after these results, has the residual value at $101m (i.e. £80m again), so I’m not really sure what the correct number is here. It’s worth noting that the estimate made in the 2010 prospectus was $110m, so it’s fallen over the last decade in dollar terms.
Since 2010, depreciation charges have reduced the asset value of the plane down from its original cost of £114.5m to £84.5m.
There’s not much else on the balance sheet of this fund. The cash balance was £4m and borrowings were £30m. £12m of income has been received in advance it seems, so this counts as a liability for now.
So we have £88.5m of assets and £42m of liabilities giving us a net asset value of £46.5m.
There are 42.5m shares in issue, making the net asset value per share 109.5p. The share price after Thursday’s fall was 102p, but with a horrific bid/offer spread of 97p-107p.
Clearer skies ahead?
The aircraft leasing funds all released statements after the market shut on Thursday, no doubt in an attempt to calm investors’ nerves. Whether it will do so remains to be seen — their share prices were all flat on Friday morning.
Certainly, all eyes will be on the next assessment of the residual value. I think it’s due in July for Doric Nimrod Air One, alongside its next set of annual results. A quarterly update is usually produced in mid-April as well.
However, given the residual value is £63m (or is it £80m?), dare I say it, there might be a reasonable margin of safety here. The residual value could fall a fair way and still exceed the current market value of £43m.
By the end of the lease, the debt should all be paid off. What’s more, annual dividends of 9p suggest a yield of 8.8% for the next few years.
I’d stress this is just a very quick take. I haven’t looked at the other aircraft leasing funds to get a feel as to how they compare. However, this snap reaction from Quoted Data suggests they think the fall could be overdone as well.
David Stephenson, the FT’s Adventrous Investor, is a holder of Amedeo Air Four Plus and has offered an interesting take, highlighting that the lack of transactions for second-hand planes means that A380 residual values are very much guesswork.
I might look more closely at these funds in a future article, though. They appeal to the number cruncher in me!
German investors feel the pain as well
In case you think esoteric alternative asset funds are limited to the UK, this Bloomberg article reveals that German investors have also been hit by the Airbus news.
In fact, the German funds seem to be suffering for some time. The planes in their funds being leased to Singapore Airlines and Air France, who have been handing them back early.
Emirates, which seems to be the mainstay of our UK-listed funds, seems more committed to continuing to operate the A380s it already has, perhaps well into the 2030s.
The Bloomberg article notes that the German funds are trading at around half their issue price. Their UK cousins are just showing very small capital losses right now.
Alternative assets, same old risks
Many of these investment trusts that invest in alternative assets haven’t been around that long. This means we haven’t seen how they perform throughout an economic cycle.
The AIC website classifies 140 out of 400 investment trusts as alternative asset funds. Of these, only 44 have a 10-year track record. Only 80 have been around for 5 years.
Most of the time they tick along smoothly. Net asset values edge a little higher every 6 months and chunky dividends are paid out every 3. But when things go wrong, they can get pretty nasty with very little warning.
Of course, many of us focus on the income side of these funds. The risks, it seems, lie mostly on the capital side.
We saw other examples of what can happen with infrastructure funds when the chance of the Labour party getting into power increased in 2016/2017, followed up by the Carillion disaster. HICL Infrastructure, supposedly the steady man of the sector, saw its share price drop from the 180s to the 130s, although it’s bounced back pretty well.
CATCo Reinsurance Opportunities was a horror show in 2018. Its shares plunged 75% after it was hit by losses from multiple hurricanes and the wildfires in California.
Taking baby steps
Despite my concerns, I’m still making a little room for alternative assets in my portfolio. I own Bluefield Solar Income in addition to HICL at the moment.
I’m doing so in a measured way, I hope, keeping position sizes small. I’m aiming for a few different types of alternative assets, getting a feel for them over time.
I think one of my weaknesses as an investor is being a sucker for a good story. Therefore, I try to tread carefully when investing in something new.
Alternative asset funds are often touted as low risk, but remember that some element of risk is always there when you leave the safety of cash or short-term bonds.
It might lurk unseen in the background and be in a different form than you are used to. But it can still bite just as hard.
Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.
Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!
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