Boost your income with investment trusts
Of those 70, at least 30 yield more than 5%. Because investment trusts can retain some of their income as reserves, much has been made of their ability to smooth out dividend payments over the years, so the sector appears to be verdant pasture for investors seeking a respectable and growing income.
However, investors tempted by the highest yielders should be careful. Many of them have cut their payouts in recent years and have seen their net asset value (NAV) per share fall. This may not be obvious from total return figures, but it matters because it diminishes the ability to generate future dividend growth.
When looking for income, investors need to mull over the outlook for the sector in which a trust invests - including its capital and income growth potential. Then they need to consider each trust's objectives and dividend record.
Next, ask whether it can withstand headwinds - is its dividend covered and well supported by revenue reserves? Check whether income is already being boosted because a large proportion of fees and interest is being charged to capital. If that is the case, the trust may have little scope to increase income.
Finally, check how recent performance has affected the ability to grow dividends and whether it is on an attractive discount.
THE FIVE LARGEST UK GROWTH AND INCOME TRUSTS
|Price (p)||Premium to Nat %||Net yield (a) %||Revenue reserves* rel to dividend %||Fees/int allocated to capital* %||Five year dividend growth** %||Five-year NAV return capital only** %|
|City of London||289||+3.4||4.5||0.57||70||7.1||95.9|
|Edinburgh Investment Trust||444||+5.0||4.6||0.99||70||1.8||89.0|
|Perpetual Income and Growth||253||+0.6||3.7||0.75||70||5.9||104.2|
* Based on latest available annual accounts
** As at end March 2011
Sources: Winterflood, Numis, AIC
The table above shows the results of these calculations for the five largest trusts in the UK growth & income sector. Merchants Trust has the highest yield, but scores badly on most fronts. What's more, its shares trade at a 3.8% premium to NAV, so the share price is likely to underperform the underlying assets if the sector falls from favour, as it has in the past when interest rates rose.
Perpetual Income & Growth (PIGIT), on the other hand, has the lowest yield, but scores well for dividend cover, dividend growth and capital preservation, and trades on a fractional premium.
There are trusts in other sectors that yield at least as much as PIGIT and score well on other fronts. In the UK growth sector, for instance, they include Keystone and JPMorgan Claverhouse. Mark Barnett manages both PIGIT and Keystone and their portfolios are very similar. But Keystone trades on a wider discount and yields slightly more.
Claverhouse has raised its dividend every year since 1972, and although the dividend has been uncovered for the past two years, its dividend reserves are still equal to nearly a year's payout.
Trusts in the UK high income sector offer high yields but have mostly struggled to maintain their dividends or increase capital. City Merchants High Yield and New City High Yield both yield over 6%, with the latter achieving impressive dividend growth. The catch is that both invest in fixed interest securities. New City, meanwhile, is trading on a sizeable premium.
Overseas income has become increasingly popular, but that means the better-quality trusts - such as Murray International and the three offshore Asian income companies - all tend to trade on premiums to NAV.
So do recent launches such as JPMorgan Emerging Markets Income, while newcomers such as Henderson International Income market their shares at a premium once launch costs are taken into account. This should not deter investors who believe in their long-term potential, but increases the share price downside if they do poorly or their sector falls from favour.
Established overseas equity trusts that combine decent yield with discount to NAV include Jupiter Primadona. It yields 3.8%, its NAV per share is up 34% over five years, and it is aiming for continued dividend growth. Yet its discount is 8%.
Midas Income & Growth is on a similar discount, although it yields 5.8% and has grown its dividend impressively. Its rating reflects disappointment with a 20% fall in its NAV per share over five years.
Looking to Europe, JPMorgan European's income shares combine a 4.1% yield and respectable performance record with a 10% discount. However, the 5.4% yield on Netherlands-based European Assets needs careful analysis as it is distributing capital, not income.
Ordinary income shares of split-capital trusts can combine a well-above-average income with capital growth in good times, but they are usually highly geared by other share classes so can suffer badly in market setbacks. The ordinary income shares of Ecofin Water & Power Opportunities are among the most interesting.
A trio of income choices
Troy Income & Growth Trust 3.6% yield
This is an interesting UK growth & income trust because it has a zero discount policy - so there should be minimal downside risk from the discount to NAV widening.
Also it is well placed to grow its dividend as last year's payout was fully covered, only 50% of fees are charged to capital, and its dividend reserves are equal to a year's distributions.
Formerly known as Glasgow Income Trust, it has been totally overhauled since Francis Brooke of Troy Asset Management took charge in August 2009. It now has an ungeared, sectorally diversified and defensively oriented portfolio of around 40 companies, with a third in medium to smaller companies.
Brooke has a good record as manager of Trojan Income fund, which has been exceptionally resilient in difficult markets, and the investment trust is similarly managed. Brooke is also a significant investor in his funds.
International Public Partnerships 5% yield
The five offshore infrastructure investment companies trade at premiums because they offer attractive yields and should produce steady capital growth. They invest in public infrastructure assets developed under Public Private Partnership and Public Finance Initiative procurement methods, such as hospitals and schools.
The income from these concessions should be reliable as it derives mainly from 20 to 40-year contracts with the public sector. Income is generally inflation-linked, but operational costs must be tightly controlled.
Launched in November 2006, International Public Partnerships is one of the best-established and yields 5%. It is raising its dividend by 3% a year and its 2010 payout was 1.2 times covered.
Its NAV per share has gained 11.3% since launch with scant volatility. The portfolio is geographically diversified, with the UK representing 48% and the balance mainly in Australia, Belgium, Canada and Germany.
Transport, education, health and courts of justice dominate in sectoral terms, and it has high hopes for its exposure to offshore electricity generation.
Ecofin Water & Power Opportunities 5.3% yield
The trust invests in a globally diversified portfolio of utilities and related companies, which historically have been a good base for a geared trust as they offer a reliable yield and relatively steady capital growth. This has allowed the trust to raise the dividends on its ordinary income shares by 30% over the past few years, to give a yield of 5.3%.
Chairman John Murray says dividend cover in the year to 31 March was 1.1 and revenue reserves are equal to around a year's distributions. Companies with no yield make up 30% of the portfolio, some of which could be easily switched into higher yielders if needed to bolster the dividends.
Given that the shares' attractive yield has been supported by a 30% rise in NAV over five years, the 30% discount seems an anomaly.
However, there are two main causes for concern. First, the utilities sector is facing growing regulatory and political risks, especially in the UK and Europe. And second, those regulatory risks have persuaded Invesco Perpetual to start running down its 28.7% stake in the ordinary income shares, creating selling pressure.
Murray counters that only 18% of the portfolio is exposed to "classic regulated utilities", its US exposure has been raised to 50% as the regulatory regime is more benign, and the renewables sector should benefit from Japan's nuclear disaster.
Murray and manager Bernard Lambilliotte both have large stakes in the trust and the management company.
This article was taken from the May 2011 issue of Money Observer.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).