Investment trusts can have their advantages – but be wary

The cost of living, as measured by the consumer prices index (CPI), fell back to 1.9 per cent in January, down from 2 per cent in December, and notably marking the first time in more than four years that inflation has dropped below the Bank of England’s 2 per cent target.

While the fall was welcomed, many are still trying in vain to get a decent return on their savings and with the average UK Equity Income investment trust, currently delivering a yield of well over 3 per cent, according to the Association of Investment Companies, the attraction for high-yielding closed-end vehicles is obvious.

But while investment trusts can provide a good way for investors to gain access to dividend producing shares with a competitive charging structure, they have a number of facilities at their disposal which play in their favour.

Gavin Haynes, managing director, at Whitechurch Securities, says: “One of the most obvious advantages investment trusts have over open-ended funds is that they have the ability to smooth out dividend payments and overall returns. A trust is allowed to hold back up to 15 per cent of the dividends generated by the underlying portfolio.”

This buffer of cash, which is placed in a revenue reserve account, can then be used to supplement dividends in future years should the dividend income from the underlying portfolio disappoint due to dividend cuts.

“This can prove an excellent way for trusts to build up long records of dividend growth,” adds Mr Haynes.

Given that investment trusts have the ability to borrow money, or gear-up to leverage returns and the yield, this can boost their returns. But as James Calder, research director of City Asset Management, points out: “Investing £1.50 for the price of £1 can of course be attractive but there is a significant risk here too, because in a falling market this will only serve to increase any losses.”

Investment trusts can also enjoy the benefit of being fully invested, as they do not have the same redemption issues as mainstream funds, which helps in an environment where the rate of return of cash on deposit is negligible.

Mr Calder adds: “A closed-end structure can also buy into more illiquid asset classes which pay a decent income, such as floating rate notes and property.”

Of course given that investors can snap-up shares in an investment trust at a discount is another unique selling point for closed-end funds, as this can enhance the yield on offer.

But due to popularity, performance and the current demand for income, advisers and investors need to keep a watch on pricing levels as many popular trusts can move to a large premium at times, which can have the opposite effect.

Notably, according to AIC statistics, the UK Equity Income and Global Equity Income sectors are respectively delivering typical and attractive yields of some 3.6 per cent and 4.3 per cent.

However the rub is that many of the constituents in both categories are moving toward, if not already at, the wrong side of good value, given they are also trading at average premiums of 0.5 per cent for UK Equity Income and 0.1 per cent for Global Equity Income.

Global Equity Income constituent, Murray International, following a 117 per cent return over the past five years to end of February, is trading on a premium of 5.4 per cent.

Meanwhile within the UK Equity Income stable Lowland, after a 356 per cent five-year performance, is now at a premium of 8.4 per cent, illustrating that performance and yield is at times coming with a considerable price-tag.

But that is not to say there is not value to be had – for example Value & Income, which is up 251 per cent in the period is on a 10.5 per cent discount – but keeping a close eye remains key.

Philip Scott is a freelance journalist