Holly Cook: British investors have been wading through a low interest rate environment in the UK for three years now. Here for Morningstar.co.uk, I'm joined by Szymon Idzikowski. He is a closed-end fund analyst at Morningstar and he is going to help me look into one of the tools that income seekers can use.
Szymon, thanks very much for joining me.
Szymon Idzikowski: Thanks for having me here.
Cook: So what is it about investment trusts that income seekers can use to help them actually find this income that they need to add to their portfolio?
Idzikowski: Well there is actually a few advantages that investment trusts have. One of them is revenue reserve and we actually have written a number of articles which are on our website. Basically what it is, it's an account that an investment manager can use to save part of the income when the underlying companies pay more income and then just use this income during cleaner years.
But then another big advantage is actually boards’ commitment to grow dividends. So, there are a number of investment trusts that have been growing dividends for over 40 years, and I think this is something very unique.
Cook: So investment trusts versus, say, open-end funds or ETFs, are there any specific qualities that go with those investment trusts and other closed-end funds that an income-seeker would find particularly useful?
Idzikowski: Well the two things that I have mentioned are actually very specific for income [investment] trusts, but then on top of that what – especially if you compare to ETFs, ETFs are trying to replicate and match the index, while income [investment] trusts and actually open-end funds they will try not only to manage the returns of the index but to beat the index.
And I think if you are the income seeker, you should remember that at the end of the day what matters to you is the total return. So, personally, if I was looking for income funds, I'd still look at the total return and then on top of that I would like to have a growing stream of dividends.
Cook: So, are there any risks associated with this closed-end fund structure that investors should be aware of?
Idzikowski: There are some characteristics that they should understand – I’m not sure if I would call them risks, but there are definitely some issues they should look at and they should consider. So one of them would be gearing. So gearing is the money borrowed by the fund manager, as much as gearing can increase the gain of the funds, it will also increase the losses, which consequently increases the volatility and risks of the fund. That said, there are studies that prove gearing can add value over the long-term.
Another issue I would mention is liquidity. With open-end funds again, when investors wants to buy units of the open-end fund, he goes to the fund company, the fund company will create units, when he sells the fund units will be cancelled.
With closed-end funds, since the capital structure is closed and since closed-end funds trade on the stock exchange, whenever he wants to buy or sell stocks, he needs to find someone that would like to buy back or sell, right? So that can somehow restrict the ability for him to buy or sell stocks whenever he wants. But there is actually an interesting angle to that. So, again, there are studies that prove that investors buy good funds, but do this at the wrong time. So they buy when the funds trade a bit high and sell when they trade low, right? With investment trusts, when there is a market crash, since everyone is selling nobody would like to buy investment trusts from you, so you kind of flow to this position. This actually means that probably when you lock your losses, when the market reverses, you actually will make your losses good, and if you have chosen a good fund, you will actually make a gain. So people actually argue that because of this liquidity issue you commit to invest for a longer time.
Cook: So as long as an investor is aware of what it is they are getting into then these kind of issues can play into their hands, to a certain extent?
Idzikowski: Exactly.
Cook: So what is it that Morningstar does to try and help investors decipher the investment trust market?
Idzikowski: Well, there is a number of tools we provide. So, there are different screeners, rankings, for example, on the website that would help you to choose funds. We have got an education centre that would…like we just agreed you need to be aware of some of the features of funds, and we also have got two types of ratings. So we have got the Star rating, which is a quantitative rating…
Cook: So that's measuring performance?
Idzikowski: Correct. It's risk adjusted returns. There is a formula that will calculate every month for risk adjusted returns of the fund. And this is a backward looking rating. But then this year, we have actually launched Analyst Rating, which is a qualitative, forward-looking rating and together with this rating we actually also write qualitative reports, which is an assessment of the funds and give justifications for how we arrive at a certain rating and what is actually interesting about that.
We don't only talk about why we like the fund and why we don't like them, but we also talk about how this fund should be used within the portfolio, and we actually, when we're looking at investment trusts we compare them against the broader peer group. So we're going to compare them against open-end funds and we are going to compare them against ETFs.
Cook: So for an investor who is looking to ramp up the income portion of their portfolio, are there any investment trusts that jump to mind that could be suitable for them?
Idzikowski: We actually even rated a couple of income funds. So, one of them is, for example, City of London Investment Trust (CTY). It has been rated Gold. There is a number of things we like about this fund. Its fund manager is Job Curtis, very experienced fund manager, over two decades of experience. He has been actually at the helm of this fund also for 20 years. That's a tenure that is rare to see actually, and what it means is that this tenure and the longevity of the tenure adds a lot of stability to the way he runs the funds.
So when you look on the process there have not been that many changes in the process. He was following the same consistent process over the time…and it paid back. I mean, the fund has generated progressive dividends for over 45 years.
Cook: That's some record.
Idzikowski: This is actually a record that has yet to be matched by any other funds.
Cook: So that's a great tip for investors. Any other funds that we should be aware of as well?
Idzikowski: Well, there is also an interesting, actually, area…there are some funds in Asia-Pacific regions. So, historically Asian companies were not paying dividends or were paying very low dividends. That has changed recently and some funds capitalised on that. So, a good example would be Schroder Oriental Income Fund (SOI), which is rated Silver by us. The fund is run by Matthew Dobbs, also a very experienced fund manager, but what we really like about this fund is the support he gets from the analyst team. So there are 27 analysts sitting across the Asia-Pacific region.
Why do I think it's important? A big part of the process of this fund is actually company meetings. Since Matthew has got the support of 27 analysts that sit locally all over Asia-Pacific regions, it means they have got very good access to companies they want to visit and they understand very well the situation in the market. I think this is a big plus, a big advantage of this fund, and the fund has actually been launched in 2005. Since then, it has already outperformed average funds [peers] by over 2% annually, and it has also delivered progressive income.
Cook: So that's some great ideas then for income seeking investors. Szymon, thanks very much for joining me.
Idzikowski: Thanks for having me.
Cook: From Morningstar.co.uk, thanks for watching.
