Income investors are feeling the pressure from low interest rates and macroeconomic uncertainty.
Government bond yields have been very weak and a number of previously high-yielding companies have announced dividend cuts this year across the mining, industrial metals, tobacco and food retail sectors.
While economic data supports a rate hike in the US in the summer, Markus Stadlmann, chief investment officer at Lloyds Private Bank thinks UK’s economy is not growing at sufficient speed for an interest rate rise to be likely this year.
Amid the current market conditions, Stifel, a London-based brokerage firm, said that investment trusts investing in equities which have a historical dividend yield in excess of 4% may be attractive for income seekers at a time of exceptionally low interest rates, however investors have to prepare to take equity risk.
David Holder, senior investment research analyst at Morningstar agrees, saying: “Investment companies with their ability to use revenue reserves or to potentially dip into capital reserves to maintain income distributions are well placed to provide investors sustainable income.”
However, Holder also reminded investors that whist a high yield figure is an important consideration it does not provide investors with any guide for the “likely security” of these distributions.
Top Five High Yielding Equity Trusts
According to Stifel, the top five equity investment trusts with a more than 4% dividend yield are the BlackRock World Mining Trust (BRWM), Henderson Far East Income (HFEL), Merchants Trust (MRCH), European Assets (EAT) and Aberdeen Asian Income (AAIF). All of them are trading at a discount currently.
Holder said that with the exception of BlackRock World Mining investors can take some comfort that the respective dividend yields are supported by earnings and revenue reserves which should give comfort that these levels of distributions are likely to persist over the foreseeable future.
Mining Trust Tops the High Yielding Chart
BlackRock World Mining is a Silver Rated equity natural resources trust which currently yields at 9.4%. The trust underperformed in the past five years however it has generated a 47.3% return year to date.
The trust’s final dividend to December 2015 of 14p was maintained with a total dividend of 21p for the year, which has been held since 2012. However, the chairman advised investors to expect a dividend cut in 2016 as its key holdings such as BHP Billiton and Rio Tinto cutting their dividends by 75% and 50% respectively.
Holder thinks looking at the position of commodities there is some hope that the dividend, whilst reduced, will still be “material feature” for investors here in the future. However, Stifel warned that if the total dividend falls by 25%, the prospective 2016 yield on the fund declines to 7%.
Morningstar Analysts continue to believe that BlackRock’s team is one of the best resourced in the sector, underpinned by its experience and knowledge. This fund is cheaper than its Morningstar Category median fund and it is trading at a discount of 13%.
Two Asian Ex-Japan Trusts with High Yields
Aberdeen Asian Income is a Gold Rated trust with a 5.4% yield. The trust has gained 6.5% year to date and it has a 9% 10 years annualised return. The trust underperformed last year at 16.8%. Holder suggests that investor sentiment towards the trust remains a little weak after a testing couple of years of performance but that recently there have been encouraging signs with regard to improving performance. It trades on a 7% discount, slightly exceeding the boards intention to limit the discount to 5%.
Another Asian ex-Japan trust Henderson Far East Income is Rated Neutral by Morningstar analysts, and it currently yields at 7.1%, primarily from a portfolio of equities, Stifel said. The trust posted positive returns in 2012 to 2014, however it underperformed in the past year at 5.7%. It has a 8.2% 10 years annualised return. It is trading at 2.8% discount.
According to Holder, both trusts face macro headwinds such as slowing regional and Chinese growth but benefit from experienced management and supportive long term trends such as rising wealth and demographics. Both trusts have dividend cover at the current level of distributions of around 10 and 6 months respectively.
UK Equity Trusts
UK equity trust Merchants has a yield of 6.1%, with the shares on a 5% discount. This is close to its widest discount level over the past year of 7%, according to Stifel. It is not rated by Morningstar analysts.
Merchants offer investors a less exotic portfolio of UK equities with a focus on FTSE 100 companies albeit yielding 6.1%, Holder said. He added that the company has some six months of current income in reserve and has an enviable record of providing investors with 34 years of growing dividends and is managed by the experienced manager Simon Gergel who utilises some 20% gearing within the fund.
Whilst dividend cuts cannot be ruled out in the UK equity sector in the next year, Stifel does think that by using revenue reserves, this investment trust should be able to deliver a more robust level of dividend than similar unit trusts, which do not maintain reserves.
The trust underperformed in the past two years however it gained 40.3% in 2013, outperforming its benchmark by 20%. It has a 4.3% five years annualised return and a 4.6% 10 years annualised return.
European Equity Trust
European Assets has a “prospective” yield of 6%, according to Stifel, and it is trading at 0.5 discount. The trust invests in European mid and small caps and Stifel reminds investors that this trust’s dividend is partly financed by a return of capital. The trust has a 14.2% three years annualised return and a 10 years annualised return at 15%. It generated a 20.3% return in 2015. It is not rated by Morningstar analysts.
