Do investment trusts bring the same appeal for income seekers?

This article is part of
Hunt for income - November 2013

That investment trusts have a number of key advantages for income seekers is not in doubt: from gearing to the ability to reserve income, the structure is well-suited to paying a high and steady income stream.

However, the current hunger for income has pushed premiums for income trusts significantly higher, reaching double digits in some cases. With this in mind, do investment trusts hold the same appeal for income seekers?

The advantages of investment trusts for income seekers are three-fold.

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They can reserve up to 15 per cent of revenue each year. This can be put aside to boost payments in more difficult times. This ensures a smoother and more consistent income stream to investors and some trusts have considerable cash reserves set aside for a ‘rainy day’.

Lower fees and charges have also historically been an advantage for trusts. Simply put, more of the income goes to investors. Although it is controversial, FINRA (Financial Industry Regulatory Authority) recently issued an investor alert saying that investors need to be aware that distributions from investment trusts may also include a return of principal) trusts can also pay income out of capital. However, this has helped private equity trusts, for example, to pay an income and has been instrumental in narrowing their discounts.

There are other, less obvious, advantages. James de Sausmarez, head of investment trusts at Henderson Global Investors, adds: “Investment trusts can also remain fully invested, unlike open-ended funds, which have to have one eye on redemptions. This is an important advantage for income-seekers. Cash pays almost nothing in the current environment, so any cash held in a fund is ‘non-productive’, therefore the higher cash weighting in open-ended funds is likely to diminish the income.”

The trouble is, these advantages have been well-flagged. Of the 28 trusts with a net dividend yield higher than 5 per cent, only those in niche areas are currently still trading at a discount – Ecofin Water and Power Opportunities, New City Energy, Premier Energy and Water, for example. In contrast, those providing a stable income yield are, in many cases, trading at significant premiums. For example, HICL Infrastructure currently trades at a 13.6 per cent premium, Medicx at a 22.4 per cent premium and British & American at a 17 per cent premium. Gavin Haynes, managing director at Whitechurch Securities, suggests that while there are exceptions, the trusts remaining on discounts tend to be those that have not performed as well. Also, while discounts often remain steady for long periods of time, higher discounts are vulnerable to bad news on a trust. For example, Neil Woodford’s Edinburgh Investment trust quickly moved from a premium to a discount when his departure from Invesco Perpetual was announced.

Mr de Sausmarez says investors should not focus too heavily on the premium. He says: “Every now and then there will be a spike in the premium or discount but the difference between the premium or discount at which you buy, and that at which you sell, is usually a tiny proportion of your overall return in the medium to long term. For example, the Bankers Investment Trust has been trading on a 2 per cent premium for roughly two years now. What really matters is the underlying investment management team.”