Most UK equity income trusts are on a discount, which is the best value?

A research firm has ranked the sector, which contains 22 trusts, on six metrics. Faith Glasgow reveals the results.

The UK equity income investment trust sector proved a wise choice for income investors during the pandemic. At a time when businesses were struggling and dividends were being cut or suspended, trusts could draw on the revenue reserves built up over the years to continue payouts to investors.

In contrast, their open-ended equity income peers, with no rainy-day cash cushion to fall back on, in many cases had no option but to cut dividend payments to investors.

So, as a recent (24 September) research note from QuotedData points out, it is somewhat surprising that only three of the 22 trusts in the closed-ended sector are trading on premiums to net asset value - and even those are all under 2%. Discount figures have changed only marginally since the research was published.

QuotedData highlights the fact that Finsbury Growth & Income (LSE:FGT) and City of London (LSE:CTY) trust, one of the three on a premium, are not only the largest trusts in the sector but the ones pulling in new business: CTY issued more than £106 million of new shares in the 12 months to end June 2021.

Yet CTY’s long-term figures lag most trusts at just 3.9% per year over the past five years. Only two trusts, Temple Bar (LSE:TMPL) and Edinburgh (LSE:EDIN), returned less, and TMPL’s performance has picked up markedly since a managerial change last year. In contrast, FGT has returned more than 9% a year over that five-year time frame.

• Ian Cowie: this data backs up why I prefer trusts over funds
• Funds Fan: tax attack on Scottish Mortgage, and tech share tips
• Top-performing fund, investment trust and ETF data: October 2021

It begs the question of why investors persistently return to CTY. James Carthew of QuotedData points to its status as an Association of Investment Companies' (AIC) dividend hero with 55 years of unbroken dividend growth. “CTY gets a lot of attention for leading the dividend hero table,” he explains. “Additionally, manager Job Curtis has a great reputation. It’s also large, and I think there’s a tendency for people to associate size with success and solidity.”

Nonetheless, the data suggests there may be stronger candidates for anyone looking at the sector’s capacity to deliver steady total returns and reliable income streams through difficult times, and keen to capitalise on these surprisingly sticky discounts of up to 9%. “Why not pick up a bargain if you can?” Carthew asks.

QuotedData ranked the UK equity income trusts from 1 to 22 (where 1 is highest) on each of six measures: yield, five-year NAV total returns, five-year dividend growth, discount, size and number of years’ consecutive dividend growth. A simple overall ranking was calculated by simply adding the six numbers together for each trust, so the one with the smallest total tops the table.

Please scroll to the left to see the full table

Source: QuotedData. Data to 24 September 2021. 

On this basis, Law Debenture (LSE:LWDB) ranks first, bolstered by impressive NAV returns and dividend growth, while Murray Income Trust (LSE:MUT) is second. Both boast strength in terms of size and consistent dividend growth. CTY comes in eighth, buoyed by high scores on size, yield and outstanding dividend hero status.

How significant is investment style - growth versus value – in this whole equation, and in the ranking produced by QuotedData? Carthew explains that during the decade or more when value-focused investors lost out to those seeking growth potential, the trusts with the lowest-yielding portfolios had a better chance of providing the best total returns.

He says: “That favoured trusts like Law Debenture (with its trustee business) that could supplement their income and invest in lower-yielding stocks, and those like Finsbury Growth & Income that never tried to pay as high a dividend as the other trusts.”

When value started to come back into fashion last November as coronavirus vaccines emerged, the investment landscape shifted. Trusts such as MRCH and Lowland (LSE:LWI) have had a terrific year, as did the newly revived TMPL.

All three have seen NAV gains of more than 40% over 12 months to 12 October, according to Winterflood data, despite the subsequent pause in that run. “TMPL’s managers think that there is more to go for and the stocks that they hold are still cheap,” adds Carthew.

• Bargain Hunter: six trusts that are not usually this cheap
• Andrew Pitts’ trust tips: Nick Train available on a rare discount
• Jeff Prestridge: Baillie Gifford’s rare and powerful statement

More generally, there are clearly trade-offs between the factors to be weighed up for every trust, and investors’ priorities are bound to differ. For instance, those already heavily reliant on investment income may attach greater importance to, say, a substantial and growing dividend, while those who don’t yet need to draw an income are likely to be more interested in the long-term total return performance.

However, Carthew suggests there are some basic principles worth bearing in mind when assessing UK equity income options. For a start: “Go for a trust over an open-ended fund – the ability to build up and use revenue reserves is a key advantage for trusts.”

Second, he suggests resisting the temptation to be too greedy for a high yield, “as that can come at the expense of lower overall returns”.

He also warns against favouring trusts that invest in a narrow group of large-cap income stocks: “Diversification is important.” That’s particularly the case for income investors when dividends are potentially under threat.

And finally, with inflation becoming an increasingly significant consideration for income investors, he suggests thinking beyond simple dividend hero status. “The ability to grow dividends ahead of inflation over the medium term is perhaps more important than a record of edging a dividend up every year,” concludes Carthew.