Boost your income with investment trusts

Published by Fiona Hamilton on 24 May 2011.
Last updated on 25 May 2011

More than 70 investment trusts and offshore investment companies produce a dividend yield in excess of 3.5% - usefully higher than the 2.9% yield from the FTSE All-Share index.

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.


  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
Merchants Trust  410  +3.8  5.6 0.65  65 2.7 80.9
Perpetual Income and Growth 253  +0.6  3.7 0.75  70 5.9 104.2
Temple Bar  886  +0.6  3.9 0.94  90 3.6 107.9

 * 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

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.

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