Interactive Investor

15 investment trusts yielding 5% or more: the key things to consider

26th July 2023 11:04

Kyle Caldwell from interactive investor

High yields are tempting, especially with inflation at stubbornly elevated levels. But it is important to look under the bonnet to assess sustainability, as Kyle Caldwell explains. 

For the first time in more than a decade income seekers are spoilt for choice, as equities are no longer the only game in town to procure high yields.

Cash-like investments, such as money market funds, are typically offering yields of 4% to 5%, while the types of bonds viewed as the lowest risk, such as gilts, are offering similar levels of income. Those who move further up the fixed-income risk spectrum will find higher yields. Bond yields across the board have been driven higher by interest rates rising notably over the past 18 months.

However, while bonds are certainly attractive again for income seekers, investors buying individual bonds today who are looking to hold them to maturity are currently accepting a below-inflation income return. In contrast, while there’s no guarantee, dividend-paying equities offer the prospect of inflation-beating returns through a combination of capital growth as well as dividend returns.

Job Curtis, fund manager of City of London (LSE:CTY) investment trust, one of our Super 60 investment ideas, observes that as companies grow their profits, and their dividends, this provides dividend growth over the long term. However, with bonds “the interest is fixed”.

Speaking to interactive investor, Curtis said: “I think this is particularly important in a period when you’ve got inflation. In real terms, if you’ve got a fixed-rate deposit or bond, and inflation is around 8%, within a year your money has lost 8% of its purchasing power.

“While in an equity fund, you’ve at least got the growth in income, which can alleviate that inflationary effect.”  

For investors sizing up collective investments, there’s more options than usual due to declining share and bond prices, which has pushed up yields.

In the case of investment trusts that predominately invest in equities, there’s now 34 with yields of 4%-plus, up from 25 when the research was previously carried out in February 2023. Investment trusts with assets below £100 million were excluded. 

Nearly half – 15 in total – have dividend yields of 5% or higher, as shown in the table below.

Stifel, the analyst firm which crunched the numbers, says that most of these investment trusts “have a good record of delivering annual dividend growth”.

Investment trusts primarily investing in equities with a dividend yield of 5%-plus 

Source: Stifel and Datastream. Data as at market close on 17 July 2013. Past performance is no guide to future performance.

The key things to size up with these high yields 

Among the 15 trusts are long-established UK equity income portfolios Merchants Trust (LSE:MRCH), JPMorgan Claverhouse (LSE:JCH), and City of London. The trio are ‘dividend heroes’ having raised payouts for 41, 50, and 56 years respectively.

Most of the highest yielders, however, invest in overseas markets. Topping the table with a dividend yield of 10.1% is Henderson Far East Income (LSE:HFEL).

Other high-yielding options for Asia or emerging market exposure include JPMorgan China Growth & Income (LSE:JCGI)abrdn China Investment (LSE:ACIC), and abrdn Asian Income Fund (LSE:AAIF).

However, there’s a few things to bear in mind when considering these high-yielding options. First, investment trusts tend to be more volatile than funds over shorter time periods due to discounts potentially widening and their ability to gear (borrow to invest), so make sure you are comfortable with that.

Second, consider the strength of the dividend reserves, which enables investment trusts to bolster dividend payouts in leaner years. The revenue reserve figure, expressed in years, is published on the Association of Investment Companies (AIC) website.

A third consideration is that some trusts pay dividends as a fixed percentage of the net asset value (NAV). Typically, these pay out 4% of NAV per annum as a dividend, often calculated using the NAV at the trust's year-end. Therefore, investors need to be aware that in years when the NAVs on these trusts falls, the total dividend paid and the prospective yield in the following year are also likely to decline. Of the 15 trusts, three operating in this manner are European Assets (LSE:EAT), BlackRock Latin American (LSE:BRLA) and JPMorgan China Growth & Income (LSE:JCGI).

How income is generated from the underlying investments is also important. Some investment trusts finance their dividends from capital as well as income. This approach is all well and good when capital returns are being delivered, but it tends to be more erratic when stock markets are more volatile. 

In addition, Stifel expressed caution over BlackRock World Mining Trust (LSE:BRWM) yielding 6.6%. It points out that the commodities-focused trust pays out all its income as dividends. Due to this “the dividend may be reduced at times when the underlying mining companies cut their dividends”.

It's been a strong couple of years for the mining sector, with big dividends paid, including special dividends. However, historically the sector is not a reliable dividend payer. Mining company dividends fluctuate depending on the performance of the iron ore price. In addition, some firms have strict dividend payout ratios. As a result, if they make less money, dividends are cut.

Going forwards, Stifel says in regards to BlackRock World Mining that it “would not be surprised to see a lower dividend paid in the current year to 31 December 2023, compared with the 40p paid in the past year to 31 December 2022. However, it seems reasonable to expect that even if the dividend is reduced, the dividend yield would remain in excess of 4%.”

Another thing to bear in mind is that high yields do not mean market-beating returns from a total return perspective – when both capital and income are combined. In addition, dividend growth may be higher for trusts with lower yields today. 

Finally, while there are no excessive premiums, there are a number of modest premiums. As a result, investors who are buying today are paying more than the underlying assets are worth.

In general, investors should be cautious when a premium is 5% or higher due to the fact that premiums do not tend to be sustainable over time.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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