There are a number of investment trusts that offer an attractive combination of both dividend income and capital growth. This is because following a rule change in 2012, UK investment trusts now have the ability to pay dividends out of capital profits. This means that they can invest in traditionally lower-yielding sectors, which may offer better than average growth prospects, and meet shareholder demand for income in the current rate environment.

UK smaller companies

One option is the Invesco Perpetual UK Smaller Companies Investment Trust (LSE: IPU). Aside from its dividend yield of 4%, this fund is a classic equity investment trust that holds a diversified portfolio of small to medium-sized UK quoted companies.

Unlike equity income funds, which invest primarily in higher-yielding stocks, this fund does not prioritise higher-yielding companies over lower-yielding ones. Instead, it remains focused on identifying what the managers regard as quality businesses with strong balance sheets.

But following a change in its dividend policy in 2014, it has used its capital reserves to supplement its dividend payments, in order to enhance its dividend yield. As such, the income earned by the portfolio in the form of dividends affords just roughly half of the investment trust’s yield.

Top performer

The fund is a top performer in the small-cap equity space and has been consistently beating the performance of its benchmark in recent years. It has a five-year total return of 50%, which compares favourably to the benchmark Numis Smaller Companies ex-Investment Companies Index’s gain of 28% over the same period.

Industrials is its biggest sector exposure, representing 33% of its total assets, and this is followed by consumer services, which accounts for a further 19%. The top five holdings in its portfolio include Coats, Clinigen, Consort Medical, Robert Walters and 4imprint.

Biotechnology

The biotechnology sector has been one of the hottest investment areas over the past decade, and many stocks have delivered incredible profits for investors. However, it’s an equity space which offers very low yields, with very many companies not offering any dividends whatsoever.

The International Biotechnology Trust (LSE: IBT) is one way to get around this issue. This investment trust offers a current yield of 4.1%, via the use of capital reserves to top up its dividends.

Unsurprisingly, its past performance is impressive. Over one-, three- and five-year periods, the biotech fund has returned 14%, 25% and 170%, respectively. However, past performance is no guarantee of future returns and it’s important to consider other factors as well.

Currency risk

Investors should also be wary about the impact of currency fluctuations on capital values. As US large-caps dominate its portfolio, and the underlying firms earn most of their revenues outside of the UK, the fall in the value of the pound in recent months has boosted the sterling valuation of its underlying investments.

Should the pound recover from such lows — perhaps from progress on Brexit negotiations, then the rise in the value of the pound would hurt capital growth in the future.

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For investors looking for growth and income from smaller companies, I reckon the Acorn Income Fund (LSE: AIF) deserves a closer look. The fund is a standout performer in the UK small-cap space, boasting some of the best figures across the board.

An investor who had bought shares in the investment trust five years ago would have earned a total return of 176%, a significantly better performance than the FTSE SmallCap (excluding investment companies) benchmark’s total return of 112%.

The Acorn Income Fund invests 70-80% of its overall portfolio in UK-listed smaller companies, with the remainder in fixed interest securities. Equity fund managers Simon Moon and Fraser Mackersie use a bottom-up investing approach, picking companies with experienced and well motivated management, good cash generation, and growing dividends.

Top holdings in the smaller companies portion of the portfolio include Convivality (4.2%), Acal (3.7%), Clipper Logistics Group (3.7%), FDM (3.1%) and Somero Enterprises (3.0%).

Reduce capital risk

The inclusion of bonds in the fund helps to add income and reduce downside risk in an otherwise risky basket of small-cap stocks. Paul Smith, who manages the income portion of the portfolio, invests mainly in short-to-medium duration securities, which reflects his concerns on tightening monetary policy. He also hedges against potentially rising rates by holding short positions in government bond futures to reduce the average duration of the portfolio.

The Acorn Income Fund is attractively valued on its current discount of 6% on net asset value, which means investors can effectively purchase shares for less than the sum of its parts. Additionally, with its yield of 4.1%, the fund is also one of the most attractive from an income standpoint.

Biotech stocks

Biotech stocks have been one of the hottest investment areas in recent years as promising new drug developments and robust earnings growth lure investors to the sector. With this in mind, the International Biotechnology Trust (LSE: IBT) is a solid pick for investors expecting further significant gains.

The fund has been run by lead manager Carl Harald Janson since September 2013, who has 13 years’ experience in healthcare investing and a further seven years’ experience within the pharmaceuticals industry. Janson reckons there are still good opportunities from mega-cap firms due to their lower-than-market p/e valuations and robust top-line growth. What’s more, he also looks for smaller companies that are potential takeover targets, as he reckons the market is still ripe for M&A.

As expected, US large-caps dominate its portfolio, including Gilead (7.8%), Celgene (7.7%), Regeneron (6.5%), Biogen (5.9%), and Vertex (4.5%) – its five biggest positions. North American stocks account for roughly 85% of its portfolio, while European- and UK-listed firms account for the remainder. Its two biggest European positions are Shire (3.2%) and Denmark’s Genmab (3.0%).

Performance figures for the past five years show the trust earning a total return of 190%, beating its larger rival The Biotech Growth Trust, which gained 180% over the same period. And in contrast to its rival, which doesn’t pay any dividends, the International Biotechnology Trust has a dividend yield of 3.8%.

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Over the long run, a low-cost FTSE 100 tracker or a diversified portfolio of individual stocks stands a good chance of exceeding the first of these growth rates by perhaps 1% a year, while some of the big-name growth- and small-cap investment trusts have achieved the second. But the third? Annual mid-teens historical returns are generally confined to risky and volatile microcaps — too risky for retirement money for some — and to funds investing in specialised sectors and strategies. They’re niche products so you shouldn’t be overexposed to any one of them, but as part of a portfolio that includes some household name investment trusts, they could play a vital role in ensuring your retirement is more comfortable — and arrives sooner — than a boring tracker could achieve.

Courting success

Burford Capital (LSE: BUR) is the world’s leading litigation funder, backing corporates in commercial and intellectual property disputes and enforcing judgements for a share of the awards. It has returned a spectacular 484.8% in the past five years, a figure unlikely to be repeated as the business is now mature. Nevertheless, an average annual return of 20-25% could be within reach. Profits are dependent on judicial decisions and exchange rates (most cases being in the US), so volatility may be high, making this a choice for investors with long time horizons.

Healthy returns

International Biotechnology Trust (LSE: IBT) has achieved the highest five-year return in the hot biotech sector, at 221%. With rich countries facing ageing populations and major medical breakthroughs increasingly achieved through technology, I believe IBT’s mix of medics, scientists and financiers are well placed to continue generating 25-30% a year from a global mix of listed and unquoted investments. The trust recently introduced a 4% annual dividend — great for retirees, but those not yet in drawdown should reinvest it.

Private pleasures

Private equity-owned businesses generally outperform listed ones. But, as the name suggests, the asset class is seldom available to the public. A few listed private equity trusts represent the exceptions, Pantheon International (LSE: PIN) being the UK’s longest-established and, in my view, best. Returning 168.3% over five years, it’s hugely diversified, by fund manager, stage, scale and geography, so the 11.8% annual NAV return achieved since inception, which includes a big hit following the global financial crisis, could be beaten. Second biggest holding in my SIPP.

Stellar strategy

A handful of fund managers aim to achieve private equity-like returns by investing in small firms where they believe they can exert influence on management to execute strategic change. The shining star among these is Strategic Equity Capital (LSE: SEC), which has generated a 177.2% return for investors over five years. Its share price fell slightly in 2016 because it moved from trading at a premium over Net Asset Value to a discount, as the small-cap IT sector fell out of favour. This makes it a smart buy now, raising the probability of achieving 12-15% a year growth going forward.

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