In the current low interest rate economy, an increasing number of investors are turning to equity income investment trusts to generate yield. The UK equity income trusts sector manages £11.4 billion of assets and has a proven track record of delivering a rising income stream to investors. With interest rates are set to remain low in the foreseeable future, how investors navigate equity trusts will be crucial to encouraging future income flows.
Five tips for income seekers
After a sustained period of record low interest rates, investors remain hungry for yield and a growing number of them are turning to equity income investment trusts to generate an income.
The Bank of England base rate has been at 0.5% or below for 100 months, meaning that those who rely on their savings to provide an income have had to explore investment options beyond cash-based accounts - even at the expense of forgoing the guarantees on the value and income that cash-based accounts offer.
They are increasingly recognising the benefits of equity income investment trusts.
The sector manages £11.4 billion of assets, and the average discount at which the sector's investment trusts’ share prices trade relative to the net value of the underlying assets has narrowed from 8.3% to 3.3% over the past ten years as demand has increased, according to data from the Association of Investment Companies (AIC). This means that share prices are more accurately reflecting the value of the underlying assets.
UK equity income investment trusts have an exemplary track record of delivering a rising income stream to investors - although remember of course that past performance is not a guide to the future. One of these trusts is the Standard Life Investments Equity Income Trust, which boasts a robust yield of 3.5% and a consistent track record of not having cut its dividend for over 16 years.
1. Go for dividend growth
With consumer price inflation rising to 2.7% in April – its highest level since
September 2013 – dividend growth is even more important and investment trusts have an unparalleled track record of growing the dividends they pay to their shareholders.
Annabel Brodie-Smith, communications director at the AIC, said: ‘It’s encouraging in this time of rising inflation that 12% of the investment company sector have increased their dividend every year for ten years or longer.
‘Investment companies’ ability to smooth dividends allows them to hold back some income for tough times ahead and is a key advantage of the structure.’
Many investment trusts with an income mandate have meaningful revenue reserves that can be useful when there are dividend cuts at the companies in which they invest. These reserves can be used to smooth pay-outs if necessary, thereby delivering a more sustainable level of dividends than similar open-ended funds, which do not maintain reserves.
2. Be unconstrained
Central to the success of the Standard Life Investments Equity Income Trust is its unconstrained investment mandate. This enables its manager, Thomas Moore, to invest across a wider range of UK listed companies across all market capitalisations, beyond those usually found in more traditional UK equity income funds.
In this way, he is able to mitigate the dividend concentration risk inherent in the UK stock market. Dividends in the UK are highly dependent on a small number of companies. Almost 60% of the total value of all the dividends paid out by the 600 or so companies in the FTSE All- Share Index comes from only 15 companies.
Moore’s all-cap approach sets him apart from other equity income trusts. Building on this, Standard Life Investments’ ‘best ideas’ focus enables him to take concentrated but diversified positions in the investment team’s strongest stock ideas, regardless of their benchmark weightings. The portfolio’s active share - a commonly used measure of how much it differs - relative to the FTSE All-Share is around 90%.
3. Consider smaller companies
The Standard Life Investments Equity Income Trust has a bias towards medium and smaller size companies – so-called mid and small-cap – on the strength of their greater growth potential. For example, in the ten years to the end of 2016, the FTSE 250 Index, which includes more mid and small caps, returned 113.5%, far more than the FTSE 100 Index, which returned 66.7% over the same period.
This approach has helped to fuel strong performance from November 2011, when
Moore took over management of the trust. It has also given it relatively little overlap with the majority of other UK equity income funds, meaning it could be an ideal investment for those looking to avoid overconcentration in traditional income stocks – large-cap, defensive ‘bond proxies’ that have limited scope to grow their dividends.
Laith Khalaf, a senior analyst at Hargreaves Lansdown, said: ‘The fund is tilted towards medium-sized FTSE 250 companies, which gives it the potential for strong longer-term growth, and means it dovetails well with more traditional equity income strategies that focus on the bigger blue chips of the FTSE 100.’
4. Take a total return approach
Moore manages the Standard Life Investments Equity Income Trust using a total return approach.
He selects stocks for inclusion in the portfolio not solely for their yield characteristics, but also because of their potential to generate capital gains, to pay special dividends and/or to increase their recurring dividend per share.
‘In this environment of high [share price] valuations, with the risk that valuations come under pressure, it makes sense to focus on companies generating high levels of cash,’ he said.
5. Opt for regular income
Investment trusts increasingly distribute dividends quarterly to meet growing demand from income seekers. Almost half (46%) of conventional AIC member investment companies that pay a dividend are now paying a quarterly dividend, up from 17% in 2010.
The Standard Life Investments Equity Income Trust is one of 104 companies to do so – paying dividends in March, June, September and December each year.
Brodie-Smith at AIC said: ‘With investors still hungry for income from their investments, it’s not surprising that the number of investment companies paying quarterly dividends has increased.’
Unlike a cash-based account, the value of an investment is not guaranteed and can go down as well as up. An investor may get back less than they invested. Past performance is not a guide to the future.
For further information, please visit our investment trust web site: www.standardlifeuksmallercompaniestrust.com
The opinions expressed are those of © Standard Life Aberdeen as of July 2017 and are subject to change at any time due to changes in market or economic conditions.
This material is for informational purposes only. This should not be relied upon as a forecast, research or investment advice.
The value of an investment and any income from it can fall as well as rise and is not guaranteed. An investor may get back less than they put in. Past performance is not a guide to future performance.
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