The outlook for the UK high income sector
The UK high income sector has done well over the past three years. Its constituents' average share price total returns have been better than those of the UK growth & income sector, and their average yield is around a third higher at just over 6%.
However, there are two caveats. One is that the five trusts and three offshore funds that make up the sector have widely divergent remits, records, and ratings.
The other is that none has achieved worthwhile dividend growth over the past three years, several have had to slash their payouts, and others are warning of potential cuts.
Fixed income securities
City Merchants High Yield Trust and New City High Yield Fund both specialise in fixed income securities, so have enjoyed relatively benign conditions thanks to falling interest rates and tightening yield spreads. This has helped them to achieve the best three-year returns in the sector.
But conditions will be harder as interest rates firm up, which may undermine their premium ratings.
City Merchants has been managed since March 2003 by Invesco Perpetual's Paul Read and Paul Causer, who have been very successful over the years in identifying higher-yielding bonds worthy of upward rerating. They were surprisingly badly caught out by the collapse in financial sector bonds in 2008, but held their nerve and were rewarded with a strong recovery in 2009.
The managers believe there are still attractive opportunities to be found among high-yielding issues. However the trust's income is contracting, and it is running out of past losses to offset against tax, so this year's total payout will be down to 11p and next year's is likely to be lower still.
New City High Yield avoided the worst of the setback in 2008 so has had a smoother run. It seems to be under less pressure on the income front, and has been edging up its dividend - which is paid gross.
But investors should note that Richard Lockwood, who has been lead manager since its 2004 launch, and previously worked wonders for City Merchants, recently handed over to the less proven Ian Francis.
Smaller company specialists
Shires Smaller Companies, Small Companies Dividend Trust and the offshore Acorn Income Fund are all highly geared smaller company specialists. Shires and Smaller Companies suffered severely in the 2007/08 bear market, but have bounced back over the past 18 months.
Acorn has recovered even better, but is comparatively low yielding. Small Companies Dividend performed exceptionally well in 2002 to 2007 and offers an attractive yield despite last year's dividend cut.
This article was originally published in Money Observer - Moneywise's sister publication - in December 2010.
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%.
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.
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.
This refers to a market situation in which the prices of securities are falling and widespread pessimism causes the negative sentiment to be self-perpetuating. As investors anticipate losses in a bear market and selling continues, pessimism grows. A bear market should not be confused with a correction, which is a short-term trend of less than two months. A bear market is the opposite of a bull market.