The structural differences investment trusts have over their open-ended counterparts certainly provides them with some added appeal for income seekers but investors need to tread carefully, as some advantages can be a double-edged sword.
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.
