InvestmentsOct 30 2013

Why trusts are worth a look

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For many savers, this has meant five years searching for any investment that could pay an income in excess of inflation.

That available pool became even smaller with the advent of policy measures such as quantitative easing, which drove down yields not just on the bonds that central banks were buying, but on all assets where coupons are based on a ‘spread’ above the so-called ‘risk-free’ return on a gilt or a Treasury stock.

So what do investment trusts have to offer against such a backdrop?

While on the face of it investment trusts may seem very similar to the much broader range of open ended investment companies, there are actually several factors specific to the closed-ended sector that could favour investors searching for an income.

For equity income investors, dividend growth can be just as important as dividend yield.

Whether a client reinvests their dividends for future growth, or relies on a stream of dividend cheques to help pay the bills, a dividend that rises each year will compound over time and help offset the rising cost of living.

The Association of Investment Companies publishes a list of ‘dividend heroes’ each year. These are the investment trusts that have increased the dividends they pay to their shareholders over multiple decades.

JPMorgan Claverhouse joined a list of those with 40 or more consecutive years of dividend increases (correct to March 2013) for the first time in 2013, and to mark this occasion we ran some figures to calculate the effect on the returns from long-term dividend reinvestment.

The results were startling: an investment of £1,000 made in JPMorgan Claverhouse in 1972 would have grown to £22,999 over 40 years if the investor had taken all their dividends when paid. But if the investor had reinvested their dividends throughout, that £1000 would have grown to £140,210 after 40 years (figures supplied by Winterflood Securities).

So how have investment trusts achieved this impressive long-term record? As any investor in BP or many of the UK banks over the past few years will know, companies can and do cut their dividends.

When these dividend cuts happen, their full effect is felt by investors in open-ended funds, as these funds are required to pay out all the net income they earn in a given year.

Investment trusts, by contrast, are only required to pay out 85 per cent per cent of income received, and they can hold the rest in reserve. They can then dip into this reserve if needed in future years when income at the portfolio level is lower, thus maintaining their own record of year-on-year dividend growth.

One of the features of investment trusts is their closed-ended structure. Instead of issuing and cancelling units or shares in an open-ended fund in response to changing investor demand, they have a fixed pool of capital, which means they can take a longer-term approach to portfolio management.

This in turn means they can hold assets that are less suitable for an open-ended fund, such as direct commercial property (bricks and mortar), where a large redemption might force the open-ended manager into a sale at an inopportune time.

Not all of the illiquid assets that might be held in investment trusts are suitable for income investors – private equity, for instance, is more of a long-term growth investment.

But property in particular has returned to favour because of its income characteristics – rental income comes in a steady stream and is often subject to regular reviews.

Because of their attractive income profile, many commercial property trusts are now trading at a premium to net asset value.

Split-capital investment trusts have struggled to come back into favour since the crisis a decade ago that caused many investors to lose the money they had invested in such shares.

But splits do still exist, generally in simpler, more conventional forms than their predecessors, and they may have something to offer investors in search of an income.

Put simply, a split-capital trust has more than one share class to cater for investors with differing objectives.

Many splits will have an income share class, where investors are entitled to all the income from the entire portfolio during its (usually fixed) lifetime, as well as a predetermined wind-up value, while capital shareholders forgo any income on their shares in the hope of a bigger payout at maturity.

So far 2013 is shaping up to be a good year for new investment trust issues. The majority of launches and secondary issues that have come to the market this year offer an attractive yield – in many cases 5 per cent or above – from a wide variety of less familiar asset classes.

These range from aircraft leasing (Doric Nimrod Air III, initial yield of 8.25 per cent), to student accommodation (GCP Student Living, initial yield 5.5 per cent) and from asset-backed securities (TwentyFour Income Fund, initial yield of 5 per cent) to convertible bonds (JPMorgan Global Convertibles Income Fund, initial yield 4.5 per cent). (All data for the first half of 2013, from Numis Securities).

The income theme has continued into the second half of the year, with much focus at present on senior loans and asset-backed securities, which are seeing strong demand because they offer a floating rather than a fixed rate of income, which is seen as beneficial in an environment where interest rates are likely to rise over the medium term.

Not every investment trust strategy will be suitable for every client, although of course the same is true of open-ended funds.

But what is clear is that for those in search of an income – whether it is a higher income, a rising income, a stable income, an income from equities or a commercial property portfolio, or even aircraft leasing – it is certainly worth considering what an investment trust can offer.

Simon Crinage is head of investment trusts at JP Morgan Asset Management