A high dividend yield can make a share an attractive passive income idea for some investors. But high yields can also be a red flag for other investors.
Simply looking at yield alone however, tells us nothing about what may happen in future. After all, no dividend is ever guaranteed to last. A dividend yield is a snapshot of what a company is paying now, not necessarily what it will do in future.
Still, some high-yield shares have indeed kept on paying or even growing their dividend per share annually in recent years.
Phoenix Group and M&G are examples from the FTSE 100. But, as many passive income hunters know, the blue-chip index is not the only place to look for high-yield shares.
An investment trust yielding over 10%
For example, Henderson Far East Income (LSE: HFEL) has a market cap of £441m, far less than any FTSE 100 firm. It is an investment trust, meaning that it owns stakes in a variety of different companies.
Perhaps most interestingly from a passive income perspective, it has a dividend yield of 10.6%. It also aims to grow its dividend per share each year.
Diversifying across different firms
One of the things I like about the investment trust structure is that it often offers an investor access through a single share to a diversified portfolio.
This is true of Henderson Far East Income. It owns stakes in a few dozen companies with connections to Asia, such as Taiwan Semiconductor Manufacturing and Samsung Electronics.
That helps it gain exposure to fast-growing Asian economies, as well as benefiting from the export potential of some Asian companies. But the geographic concentration also brings the risk that if Asian economies perform weakly, the trust may too.
Not just about owning shares
There is another risk I see. That is the trust’s ownership of derivatives that let it buy shares at a certain price, or may oblige it to sell them at a given price.
Options trading can be profitable, but it also introduces an element of risk beyond that of owning a share in a company itself. If the company does well but its share price moves in a way the option writer has not anticipated, they can potentially lose money.
The options help explain why the trust offers a double digit percentage yield even though some of its shareholdings have low yields (its biggest position is in Taiwan Semiconductor Manufacturing, currently yielding 1.1%).
Some of the money comes from dividends in shares it owns: the trust focuses on cash flow generation potential from “companies with the ability to sustain and grow dividends”. But the cash to fund the dividend can also come from any profits made on writing options.
By writing options on shares it owns, the trust can hopefully aim to benefit from long-term price appreciation — and potentially also gain financially from unexpected price swings.
One to consider
That brings risks of its own though, such as writing options that turn out poorly. Funding the dividend can eat up a lot of resources.
Despite its high yield, the trust’s share price has fallen 26% over the past five years.
Still, I like the strong income story here. From a passive income perspective, I see this as a share for investors to consider.
