BLOG: Why you should consider investment trusts when hunting for income

Written by: Edward Marten
In a world of continued record low interest rates and low bond yields it's no surprise that investors have been piling into equity income funds. But do investment trusts offer a more attractive route than their closed-ended peers?

For an investor looking for a predictable income stream, investment companies have an advantage over open-ended funds as they have the power to smooth the dividends they pay to shareholders, accumulating reserves in the good times and using these to sustain dividend payments when the environment is less rosy.

This goes to explain why many investment companies have a long track record of raising their dividends every year, with City of London the first investment trust to increase its dividend for 50 consecutive years.

Investment companies are also good vehicles for investing in assets that cannot be quickly turned into cash. Investments in infrastructure projects, property, private equity and some parts of the debt market can make good long-term investments, but are unsuitable for an open-ended fund.

The universe of investment companies has expanded in recent years in response to the demand for income, with trusts investing in illiquid assets paying a decent yield attracting investors’ money. Infrastructure, renewable infrastructure and debt funds dominated the list of investment companies raising money in the third quarter of this year, according to research compiled by QuotedData.

This demand for income from alternative investments is an ongoing trend and it’s easy to see why. Looking for a source of dividends from somewhere other than UK equities helps to diversify your income streams.

Threats to dividends in the oil, mining and financial sectors run the risk of severely denting the amount of income available to investors in the UK market. What compounds the problem is that the UK market is unnaturally skewed towards these sectors. In addition, imported inflation and the difficulty of passing that onto financially stretched consumers could pose another problem for UK dividends.

The sharp falls in sterling over the past few months have flattered the performance of many funds investing overseas, including global equity income funds. For example, without seeking to make a specific recommendation Henderson International Income Trust (HINT) has benefitted from this and its net asset value (NAV) has risen by over 20% since the referendum. HINT is the only trust, in the global equity income sector, which specifically excludes the UK from its remit. It has just raised its quarterly dividend to 1.2p, up 4.3% on the previous quarterly dividend.

Investing internationally opens up new opportunities to make money for investors by expanding the pool the manager can fish in. Over the past few months, HINT’s manager’s focus has been on minimising the dividend risk in the portfolio, emphasising stocks that can grow their dividends and have relatively stable revenues.

Another way to diversify your income streams is through a multi-manager product, which invests in a range of funds. Again without seeking to make a specific recommendation, Seneca Income & Growth Trust (SIGT) offers the prospect of both capital growth and income, and aims to achieve this with lower volatility than equity markets. Yield is the key metric used when making asset allocation decisions.

Recently, SIGT’s board increased the dividend, for the first quarterly payment, by 3.4% to 1.52p per share. A new discount control mechanism was implemented in August and this should give investors confidence they will be able to enter and exit SIGT at close to NAV.

SIGT does have some exposure to UK equities but the managers focus on stocks with good dividend cover (a measure of how sustainable a dividend is). SIGT’s managers say they consider that their companies are reasonably well placed with average dividend cover at around two times earnings. This compares favourably against the FTSE 100 where the level is about 0.7 times.

Edward Marten is chief executive of investment research company QuotedData

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