Times have changed in the last 16 years. In 2004, a Republican was elected to a second term in the White House, Arsenal won the Premier League, and the Ford Focus was Britain’s best selling car. The dotcom crash was still being felt by funds and investment trusts. You could also go into a high street bank and open a cash ISA with around a 5% interest rate.
Back to 2020. The first three events could perhaps be repeated. But a cash ISA with 5% interest rate? No chance. Around 1.6% would be the best on offer.
So, what’s the alternative? Investing in the stock market. Several UK companies pay a dividend per share owned, and Edward Sheldon examined three leading dividend candidates earlier this month. A different option, however, is the investment trust.
Why investment trusts?
I like the way that investment trusts are structured with an independent board responsible for safeguarding investors’ best interests. Low ongoing charges are usually another key feature, and under current rules they can retain up to 15% of the income that they receive each year, and then use this to sustain dividends in lean years.
Companies that paid large dividends in 2019 have mostly either cut them completely, or vastly reduced them during the Covid-19 pandemic. Crucially, retained capital has allowed investment trusts such as City of London to not only maintain a dividend payment, but increase it for the 54th year in a row.
I love the maxim of Murray International Trust (LSE: MYI), which aims “to achieve an above average dividend yield, with long term growth in dividends and capital ahead of inflation”. This investment trust is currently trading at a small discount, the dividend yield is 5.73%, gained through investing principally in global equities such as Roche and Verizon. Income is paid quarterly, so gives a bedrock for a passive investor.
Managed by Bruce Stout since 2004, the trust has been in existence for over 100 years. Historical performance is strong, but has lagged its benchmark FTSE World over the last few years due to a lack of exposure to tech stocks and a higher than average exposure to the Asia Pacific region. The trust management believe that future dividend and growth opportunities will be found in this market.
For those seeking a stronger UK focus, then Merchants Trust (LSE: MRCH) is worth considering. The share price is substantially down from its high of £5.69, and as a result the yield is an impressive 7.3%. A high exposure to cyclical stock areas such as travel, leisure and aerospace has driven underperformance compared to the wider market. Recent additions to the portfolio have been centered on defensive tobacco stocks via British American Tobacco and Imperial Brands, and telecom stocks (BT and Vodafone). Manager Simon Gergal has committed to a “high and growing yield”, although it remains to be seen if this can be achieved in the current climate. The answer should become clearer as companies begin to reinstate dividends, and given the potential for share price growth as the market recovers post Covid-19, I’m optimistic that Merchants will provide an excellent long term investment.
Although investment trusts can provide yields of 5% plus, it is important to bear in mind that capital is always at risk. Risk can be mitigated through diverse holdings, something that either of these trusts can offer. In my opinion, they would be a good addition to a balanced portfolio.
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Ben Watson holds no position in any share mentioned. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.