The complexity premium

Demand for alternative assets has soared in recent years, as investors have sought yield and low NAV volatility outside the bond market in a low interest rate world. The investment trust sector has been a major beneficiary, with many new closed-ended funds launching in these very areas of the investment market, harnessing the closed-ended fund’s ability to invest in illiquid assets.

We think the concept of a complexity premium is useful for explaining the valuations of alternative asset classes, how they de-risk in the eyes of the market over time, and how investment trusts which invest in them may trade on wide discounts at times. In fact, we think it could be an interesting potential explanation for the private equity conundrum where there is a huge disparity between the discounts of the private equity sector and those trusts investing in early-stage private investments as a minority investor (such as Augmentum Fintech, Merian Chrysalis, and Scottish Mortgage in parts of its portfolio).

Elsewhere, we also think there are identifiable areas of the market where there is a premium to be earned for investing in a relatively new or newly opened-up asset class. This is true of private debt, in which space we expect to see more manager and investor interest over time, and in direct lending, as well as in the new music royalty sector. In these areas absolute returns may well be very high in the coming years or, as in the case of the debt funds, stand out on a risk-adjusted basis, with high but not excessive yields being achieved at the expense of modest credit and default risk. As the infrastructure and renewable energy infrastructure sectors have shown, investors who get ahead of the curve can sometimes earn attractive risk-adjusted returns as they ride the wave of investor enthusiasm building behind them.