Income rules investment trusts

The largest IPO was NB Floating Rate Income which raised £309m out of a total £903m worth of IPOs, against £1.7bn for 2010.

Up to the end of November 2011, combined primary and secondary market issuance came to £2.5bn, according to research company Winterflood Securities, and secondary market issuance was dominated by infrastructure. John Laing Infrastructure raised £159.2m, Infrastructure India (Aim) raised £70.3m, International Public Partnerships raised £56m, and HICL Infrastructure raised £73.4m.

In 2012 investors face uncertainty, probably some volatility and a possible widening of discounts, and maybe some liquidity problems. There will probably be few IPOs as these will be scarce until there is clarity on Europe, markets calm and investor confidence returns. But there should be IPOs in the alternative income space, such as Alcentra European Floating Rate Income Fund, which hopes to raise £150m next year.

Possible secondary market raisings includes C share issues from Henderson Diversified Income, Aberdeen Latin American and Carador Income.

Scarce sources of income

Conventional income focused trusts have become very expensive with many UK equity income trusts and all infrastructure trusts running at a premium to net asset value (NAV). However, individual trusts and sectors offer some options.

European Assets Trust yields in excess of 8 per cent and is on a discount of around 8 per cent, though has recently lost its manager so it is not clear if this trust will maintain its strong performance.

Invesco Perpetual Select Global Equity is shifting its investment policy to provide a greater income orientation with an initial dividend yield of 3.5 per cent. At present the trust only yields around 2 per cent, and can be bought on a discount of around 3 per cent, but its performance over the past three years has not been great.

Simon Elliott, head of investment trust research at Winterflood, recommends UK focused property investment trusts for their generous yields, many of which trade at discounts. However, he warns that their discounts can be volatile because the underlying assets are not easy to buy and sell, and some of these need to roll over their debt in the near future.

Some debt investment trusts are on discounts to NAV, though you should understand the underlying investments and risks of these more unusual assets. Other trusts which invest in esoteric assets include CATCo Reinsurance Opportunities (read our tip) which invests in insurance related assets, or a timber fund such as Cambium Global Timberland.

Ecofin Water & Power Opportunities which has a yield in excess of 4 per cent but is a high risk play as it is quite highly indebted and holds some special situations.

Altin, a listed hedge fund, is now proposing a dividend equivalent to 4 per cent of the NAV and a distribution of the annual performance exceeding 4 per cent. Based on its share price of $46.50 on 5 December, this would equate to a yield of 5.6 per cent, which could rise if NAV performance over the year is over 4 per cent.

However, before you buy into an alternative assets trust check the charges as some of these have very high total expense ratios (TERs). Read more on alternative trusts

If you are prepared to hold a trust for a long time and income is very important for you, you could buy into a good quality mainstream income focused trust at a premium, such as Murray International (read our tip) and Temple Bar. Infrastructure trusts offer good yields and can be less volatile than equity funds. However, if government bond yields rise this could negatively impact their NAV, though this would not impact the amount of dividend they pay and the dividend yield would rise.

Widening discounts

After initially holding up well in the market sell off, investment trust discounts have started to widen. European investment trusts are all on discounts because of concerns about the future of the euro and debt problems. However, some of these are run by the best managers and invest in high quality multi-national companies. BlackRock Greater Europe, Jupiter European Opportunities and Henderson Eurotrust have good performance records. But be prepared for some volatility in the near term while problems are being sorted out.

Private equity investment trusts are also on wide discounts, on average around 35 per cent. However these are a high risk play as they need to sell their investments to profit. With the slowdown in debt markets and poor visibility for earnings, realisations have slowed down in the past few months, after a reasonable start to the year, and the stagnation is likely to continue into next year. This means the discounts might stay wide for some time, according to Stephen Peters, investment trust analyst at brokers Charles Stanley.

If you have a high risk appetite and want to take a punt, he suggests Electra Private Equity and HgCapital Trust, or for a fund of funds approach Standard Life European Private Equity (read our tip)

UK small-cap trusts are on discounts so it could be an opportunity to pick up strong long-term performers such as Standard Life UK Smaller Companies. But this is a volatile area and could suffer if the UK economic situation gets worse.

British Empire Securities & General Trust (an IC tip)is on a discount of around 8.5 per cent but its manager is a value investor who buys discounted shares, so the actual discount of the assets is probably wider, according to Mr Elliott.

Herald, a technology trust, has seen its discount widen to more than 21 per cent which is towards the top of its six-month range of 23 to 13 per cent. This reflects a widening of discounts and weaker performance from small cap focused trusts in general. "A 23 per cent discount is an attractive entry point at which to gain exposure to a well diversified portfolio of predominantly UK and US smaller technology oriented companies," say analysts at broker Oriel Securities.

Hansa Trust has seen its discount widen to around 22 per cent, its widest in six months.

Meanwhile, Caledonia's performance has struggled in recent years and its discount has widened, but this has been a reliable trust over the long-term (read our tip) so it could be a good moment to buy in.

"Emerging markets have underperformed this year but the macro economic backdrop is positive," adds Mr Elliott. "If you can pick an emerging markets investment trust up on a double-digit discount that would be good."

Mr Peters adds that if you are a long-term investor you could buy into a Russia or India trust, as these markets have recently suffered so you could take advantage of falling share prices. Options include JPM Indian, New India and JPM Russian Securities.

But always check the trust's performance record and read its recent statements - sometimes there is a good reason as to why the trust is at a discount, so that it is far from a bargain.

If you want to alleviate discount risk Mr Elliott suggests trusts with zero discount policies or effective discount control mechanisms such as buybacks. Examples include Personal Assets, Troy Income & Growth and Finsbury Growth & Income.

Some of the investment trusts run by BlackRock such as BlackRock Greater European and Eastern European do regular tenders to control the discount. This is also a policy pursued by Standard Life UK Smaller Companies.

New launches 2011

Source: Association of Investment Companies

Sector breakdown for issuance Jan-Nov 2011

Source: Winterflood Investment Trusts