Searching For Today's Must-Buy Dividends

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By

Harvey Jones

Published in Investing on 27 April 2012

Are these income trusts strong buys in the current choppy market?

If recent market turbulence has taught us one thing, it is that we should respect the power of the dividend. Like a Duracell battery-powered toy, the income keeps banging away after those whizzy growth stocks have run down.

As I recently discovered, it is easy to go overboard on equity income. And that's what I'm about to do. I want to dive into some nicely diversified equity income funds with low charges and hefty yields, preferably between 4% and 6%.

And then I want to invest for growth, year after year. At least 20 years, in fact. And possibly beyond.

Give it some stick

I already hold two equity income funds. Inevitably, one of them is Invesco-Perpetual Income, run by you-know-who (Neil Woodford, in case you don't). The other is Rathbone Income, managed by Carl Stick.

They're both good funds, returning 53% and 57% respectively over the past three years. The trouble is, they're both unit trusts, with pricey total expense ratios (TERs) of 1.68% and 1.56%.

Those charges take a hefty bite out of the funds' annual yields of 3.8% and 4.13% (as an aside, it's interesting how Rathbone wins on growth, TER and yield).

One alternative is to simply top up my portfolio of dividend-yielding stocks such as GlaxoSmithKline (LSE: GSK), Royal Dutch Shell (LSE: RDSB) and Vodafone (LSE: VOD).

But this time, I'm looking to see if an investment trust (or three) can do the job instead.

Income, at a premium

One drawback with dividend-paying investment trusts is that they tend to trade at a premium. Good examples are City of London Investment Trust (LSE: CTY), which has increased its dividend for 44 consecutive years, and Neil Woodford's Edinburgh Investment Trust (LSE: EDIN). Both trade at a premium of around 2% to 3% to net asset value.

That shows how highly investors prize them, but I don't like buying trusts at a premium, especially since it knocks the yield. I want a discount, please.

So what did I find?

From little acorns…

I started my search in the UK High Income investment trust sector and stumbled across an investment trust I had never heard of before, called Acorn Income Fund (LSE: AIF), from Premier Asset Management.

This fund has already grown into a mighty oak, returning 198% over the past three years. It also yields 4.52% a year. Despite that, it is trading at a discount of more than -15%.

Why?

John McClure's fund is 75% invested in smaller companies, and is clearly making some big calls, with its largest holding RPC Group (LSE: RPC) making up nearly 9% of the fund, and Fool favourite James Halstead (LSE: JHD) totalling 8%.

In fact, its top 10 holdings make up 50% of the fund. Diversified, it ain't.

That explains its sharp outperformance (its benchmark UK high income sector delivered 88%) and also its high TER of 2.41%.

Small Companies Dividend Trust (LSE: SDV) from Chelverton Asset Management has returned 162% over three years, yields 6.4% and trades at a -3% discount. Again, the TER is the blow, at 2.46%.

Both funds look impressive, if you think now is the right time to invest in small companies. And if you can stomach those charges.

True blue

Next stop, UK Growth & Income, home of solid blue-chip funds such as the top-performing Troy Income & Growth Trust, which returned 112% over three years and yields 3.6%, but trades at a 4% premium. Curses!

Lowland Investment Company (LSE: LWI) returned 109% over three years. It trades at a narrow -3% discount and yields 3.1%, with a low TER of 0.74%. I fancied a wider discount and bigger yield, but this looks like a contender.

Shires Income (LSE: SHRS), from Aberdeen Asset Management, boasts a spiffing 6.5% yield and has returned 98% over three years, but also trades at a small premium. Am I getting too hung up on this premium thing? It rules out another brace of income goodies, Edinburgh Investment Trust and Murray Trust, both from Aberdeen.

A -6% discount, a 6% yield and a 0.66% TER? That has a devilish symmetry to it, which is why I might go shopping for Merchants Trust (LSE: MRCH), which invests in a portfolio of FTSE 100 faves, including BP (LSE: BP), HSBC (LSE: HSBA), British American Tobacco (LSE: BAT), BAE Systems (LSE: BAE), SSE (LSE: SSE), BT (LSE: BT-A) and National Grid (LSE: NG).

Performance has been mid-table rather than market beating, matching the sector average by returning 60% (another six!) in three years. But its solid blend of stocks are highly appealing to me.

International velvet

Finally, to the International Growth & Income sector. Scottish American Investment Company (LSE: SCAM), from Baillie Gifford, is a stand-out here, returning 85% over three years and yielding just over 4%. It is trading at a small discount, with a 1.08 TER.

Murray International (LSE: MYI), from Asia specialists Aberdeen Asset Management yields 4.1% but is trading at a whopping 5.9% premium. TERs tend to be higher in the international sector, and Murray charges 1.23%.

Bankers Trust (LSE: BNKR), from Henderson Global Investors, is an international fund with large UK exposure and a relatively humble three-year return of 43%, which explains the -11 discount. The yield is a bit soppy at just over 3%. Its TER is a very lowly 0.42%, but low charges aren't everything. No, really.

My favourite here is the British Assets Trust (LSE: BSET), two-thirds invested in UK shares. It is up 58% over three years and yields a juicy 4.9%. It trades at a small -2% discount, has an acceptable TER of 0.74% and a track record that stretches back to 1898.

In trusts we trust

There is no single fund out there that meets my criteria. The best performers inevitably trade at a premium. Right now, I'm leaning towards Merchant's Trust, British Assets and Acorn Income.

Or do you have a better idea?

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> Harvey Jones owns shares in BP, GlaxoSmithKline, Shell and Vodafone.

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Comments

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TimBlx 27 Apr 2012 , 12:20pm

Well its true that Acorn has gone up a lot since April 2009 - but it had lost a lot before that! Over the sort of term you are planning for,10y, MYI is up 141% and AIF is up 43% . That's ignoring divis.

Jonesey12 27 Apr 2012 , 1:22pm

Acorn does scare me somewhat.I would rather invest after it has fallen, rather than risen. Especially by so much. Is the outlook for smaller companies? I'm not sure…

Harvey Jones (article author)

leftandright 27 Apr 2012 , 1:25pm

Why does AIF's lack of diversification explain its high TER?

ScillyFool 27 Apr 2012 , 1:49pm

One Trust that seems to escape most people's radars is Aberdeen Smaller Companies High Income Trust, currently on a discount of -18.05% but with a yield of 4.90% and paying quarterly dividends. Top 10 holdings - Oxford Instruments, Morgan Sindall, RPC Group, XP Power, Fenner, Balfour Beatty 10.75%, Euromoney Institutional Investor, Bellway, Aviva 8.75% and Melrose. Nice mix of good smaller companies and fixed interest. Mind you it hasn't raised the dividend for a couple of years, but certainly one to watch.

GolfingTaz 27 Apr 2012 , 1:54pm

I hold a healthy amount of MRCH in my SIPP. I like the stocks they hold, the TER is low and the yield is pretty good! I know it's not the best performing trust ever, but it is mid table and seems very stable. Plus I don't have enough in my SIPP currently to diversify well enough through equities alone, so this trust really fits the spot for me.

richjfool 27 Apr 2012 , 1:56pm

Watch out for risk and volatility levels when comparing one trust with another.

taken2often 27 Apr 2012 , 2:03pm

I may be wrong but an Investment Trust is a form of trading company. All have expenses. If you get 4.5% dividend plus after expenses this has to be much better than Unit Trusts with all their hidden expenses. As to a premium this is included in all shares where there is a demand. In the case of IT the demand is coming from the dividend. Purchase just after the dividend payment may help to reduce this.

Cheers

mcecaro 27 Apr 2012 , 2:45pm

taken2often

true, the yield on most of the trusts should be higher but you are not considering one feature which is "revenue reserve" which smooths payouts when there is a revenue shortfall.

Merchant trust is yielding 6% with more 50% invested in the best of the best of the FTSE100

the leverage is covered by long term debt...check it out of you are looking for UK equity income...

HilaryHames 27 Apr 2012 , 3:47pm

Obviously if you buy a trust that is trading at a premiuim then the underlying basket of shares is worth less than you pay. But, some of these trusts are consistently at a high premium so does it matter. When you sell, as long as the share price is higher than you boought at surely that is all that matters? Otherwise how are you ever going to buy into some of the better performing trusts? I see so many aarticles that say oh, this is such a good trust, but, oh dear, the premium is high. Trusts like Murrays and Edinburgh arent going to lose the premiium overnight are they? Surely it only matters if you are buying a trust without a long term excellent record or one in a niche sector that might go out of favour?
Would be interested in peoples views I keep mulling over various trusts and then never buy becuase I keep coming up agaianst the high premium problem
Thanks Hilary

Confabulor 27 Apr 2012 , 3:59pm

One could also consider holdings quoted on smaller European exchanges.

Examples are GBL, Sofina, Brederode, Bois Sauvage and Ackerman van Haren all quoted on the Euronext. Legally they are public companies and publish normal annual accounts. As such they have no true TER and one has to check the operating, salary, investment costs in the annual reports.

They are very similar to Investment Trust but have the advantage that very often have stable "old money" shareholder who has a large shareholding in the holding. As the majority shareholder tends to live of the dividends paid by the holdings, similar to the Investment Trusts, a lot of the earnings are retained to smooth out future dividend payments, to buy back their own shares, or to make additional investments. As they are quoted on the stock exchange and due to the fact that they retain part of their earnings their share price tends to be discounted 10 to 30% compared to their NAV.

Compared to Investment Trusts these type of holdings hold a very small number of participations. The fact that they call it participations implies that they do not only invest but want to exert some control over their participations. Due to the very small numbers of participations they have a higher risk profile than British Unit Trust but a holding like GBL (www.gbl.be) is very much a real value play, yielding about 4%. Valued at about 10 billion Euro GBL is big enough to issue corporate bonds to finance additional investments itself if they consider the market conditions to be right. This gives “small investors” the exposure to a slightly geared investment at an acceptable cost.

I like the concept because of the high transparency, their long term value view, and especially because they have a stable shareholder who does not demands quarterly benchmarking against an index.

Maybe a bit “exotic” for British fools, but in essence very close to an Investment Trust with a strong owner/manager. I am sure the British investment landscape has vehicles that behave very similarly, but I am not aware of them.

globally 27 Apr 2012 , 4:23pm

About three years ago, I bought shares in Value and Income Trust for two main reasons. Firstly, they were trading at a discount to NAV of about 20% and secondly, apart from its equity portfolio, the Trust had exposure to smaller commercial, industrial and retail property units which, I understand, even now have an average overall lease length unexpired of some 14years. Property accounts for about a third of the Trust's total portfolio with equities and cash accounting for the rest. The shares have risen significantly since I bought them back in 2009 but still yield more than 4% and currently trade on a discount to NAV of around about 15% with the equity portfolio due for revaluation on 1st May. Furthermore, the dividend has been increased each year for the last twenty four years. Even so, because of its unusual structure, this is not an Investment Trust share that will necessarily appeal to everyone, and I am not for one moment recommending that anyone should buy them. However it may be a share for the watch list and a far more detailed and thorough analysis than my brief comments have revealed. I would be most interested to hear what other MFs think about Value and Income Trust.

rober00 27 Apr 2012 , 4:54pm

I hold a number of the trusts mentioned above and have held several others in the past.

I specifically hold V & I for its reasonable dividend and its retail property element which normally stands at 50% or so.

I am not concerned about a 2or 3 per cent premium and have often found that it is fairly stable in the ITs I buy.

Of more concern and not mentioned in this article is share spread which can on occasion be 5% or more. One to watch out for in respect of smaller or more specialised trusts. Indeed liquidity in general can at times mean that you cannot always obtain a live price.

Luniversal 27 Apr 2012 , 5:01pm

Please read the research on the Investing for Income board before falling for stuff such as British Assets, whose record of (not) growing dividends in line with the cost of living is execrable.

Many of these so-called high yield trusts are consuming capital capacity or resorting to one-off tricks (e.g. Merchants's option-writing) to keep headline yields high. Acorn and Chelverton have very jagged histories. Contrariwise, Bankers may seem dull but its revenue reserve is colossal and could be broken open to pay more.

If you are investing for an immediate income return, or hoping to build up a nest egg by ploughing back dividends into an IT's commission-free plan so you can draw a bigger income from them years later, why give two hoots about whether there is a titchy premium rather than a titchy discount on the net asset value? This is sheer superstition or silly pride. "Pay over the odds? Not me."

Moreover, beware of trusts which boom '40 years of continuously increasing dividends', such as Alliance, without saying that the increases are so small that the payout is constantly losing purchasing power from year to year.

It is unclear whether the author wants dividends for their own sake, for spending, or because he has despaired of capital growth after 12 years of the market going slightly worse than nowhere and thinks that reinvesting income will give inflation-beating growth instead.

A lot of people have piled into trusts with that aim in mind, or merely because interest on cash and bonds is so laughable, and chased the trusts' prices up. Not that they are all bad bargains now, but you have to look below the surface and a good long way backwards to sort sheep from goats. Bridling at premiums or salivating over headline yields does not do the job.

tux222 27 Apr 2012 , 5:37pm

One way to look at discounts. If a trust yields 4% and has a TER of 0.5%, its management cost is reducing its yield by 1/8 or 12%. If it trades at a 12% discount that increases the yield by 12%, and you are getting the management for free (which is probably a better bet than paying 0.1% for a computerized tracking program).

Anyway, unless you really rate the management, don't buy income or general trusts at a premium, or even at too small a discount.

ArkWelder 27 Apr 2012 , 8:36pm

Some of these trusts also hold fixed interest securities so check that this fits in with your expectations: might come as a shock to find that your smaller companies fund holds a big chunk in large-cap corporate bonds.

Do the trusts operate discount control? You may just find that you wait a very long time before they open up to a 'worthwhile' discount - if they ever do. The discount/premium used to be a good indicator for sectors that were in or out of favour, but less-so these days - on the whole...

Far better to select a trust on its investment merits and which fits in with your requirements (and any other investment, for that matter). If you manage to buy at a discount then that is a bonus.

Lowland might have a lower yield, but this should open up the number of potential investee companies and that may allow greater opportunity for growth of capital - and at a faster rate than re-investing dividends in higher-yielders may provide. Will high dividends be the main return over the next 20 years? Possibly. Over the next few years or so. But at some point, 'normal growth will be resumed'.

My long-time holding in the UK G&I sector is Temple Bar. Can't remember whether or not it was originally bought at a discount, but subsequent purchases have mainly been at a premium - there have not been all that many times that it has traded at a discount, that I can remember (although 'remembering' is an increasingly decadent luxury..), but I do not regret having made subsequent purchases at a premium. Whilst I will not be selling, I have recently started to build up another holding, mainly because TMPL is generating around 12% of my income, so it's a 'comfort factor' move. And the new holding is in Lowland, and is more for the total return - but with the expectation this will derive more from growth than income going forward: it is part of my '10-year view'.

jongleur100 27 Apr 2012 , 10:08pm

Personally, I'd wait for another dip in the markets, to catch some of these useful income ITs (e.g. TIGT, EDIN, CTY) at a discount.
I'm glad I bunged a lot into EDIN when it was below 450p. But I'm a little apprehensive of the longterm effect of Woodford's performance fee.



jaizan 27 Apr 2012 , 10:22pm

I wouldn't assess performance over a mere 3 years.

Has to be 10 years, or near to it AND the same fund manager needs to be in charge.

timg7777 29 Apr 2012 , 12:22am


In battle of the S&P, can bulls gain the edge?
2012 will be the greatest year for the stock market since 1995. No significant pullbacks. Apple at 1,100 by December. I am worried about 2013.
My market strategy this days: just track the smart money movement..
How?I’m using Algorithmic systems (like “ I Know First” or “TW” ).
For example:
I saw the smart money movement on March 29 and bought AIG .
AIG rose by 16% in 1 month!
Good luck!

Gengulphus 30 Apr 2012 , 12:03am

Finally, to the International Growth & Income sector. Scottish American Investment Company (LSE: SCAM), ...

Anyone who buys something with that symbol is braver than I am! ;-)

Gengulphus

Boötes 30 Apr 2012 , 7:19pm

I wouldn't assess performance over a mere 3 years.

Has to be 10 years, or near to it AND the same fund manager needs to be in charge.

"Well said Jaizan" - forget all this chit chat about 1-2-3 years.....as you say, focus on the genuine long run returns, and by definition it has to be with the same manager - that's why we like ITs right! They're not managed by pimpled faced stock jockeys (little harsh...) :)

My long-time holding in the UK G&I sector is Temple Bar. Can't remember whether or not it was originally bought at a discount, but subsequent purchases have mainly been at a premium - there have not been all that many times that it has traded at a discount, that I can remember

Hear hear Arkwelder (the mind boggles).....Alastair Mundy is one of the best, and a rarity - a real dye in wool value guy!

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