Henderson Diversified Income has strong 2014

The fund aims to provide shareholders with a high level of income and capital growth over the long term by investing selectively across fixed income asset classes including secured loans, high yield and investment grade corporate bonds.

Libor plus 1.25 per cent is a relatively easy benchmark to beat as it currently equates to about 1.75 per cent because of low interest rates. Henderson says that when rates rise beating this benchmark will be more challenging.

The benchmark is also relevant in that the investment trust levies a performance fee, which is payable if the trust's total return in that year exceeds the benchmark return for the year at a rate of 15 per cent of such excess. However, there is an overall annual cap on total fees (base fee and performance fee) of 1.5 per cent of net assets in any financial year, and no performance fees were paid until 2012 although the trust launched in 2007.

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The ongoing charge of 1.08 per cent rises to 1.87 per cent if the performance fee is included.

Over one, three and five years HDIV did not do so well against sector peer Invesco Perpetual Enhanced Income (IPE) in share price terms. HDIV offers a yield of 5.44 per cent against a yield of 6.63 per cent for IPE. However, the Invesco trust has a different asset mix and investment focus - for example, unlike Henderson Diversified Income, it does not have investments in loans.

The ability to invest in loans could be useful if interest rates start to rise, as is expected later this year. Henderson Diversified Income's manager John Patullo says that we are in an "unusual macro backdrop that could persist for years", but the trust has a "flexible mandate which offers the ability to exploit deflationary and inflationary environments" and that there are "opportunities via industry themes such as telecoms, banking and insurance".

"Over the last three years we have been in the deflation camp and it has worked well," he says. "We also have a free remit - for example, today we are around 30 per cent invested in loans but have had as much as 80 per cent."

The trust trades at a premium to NAV of 2.58 per cent, but Mr Patullo argues that this premium is worth paying due to the trust's good track record.

The trust also has some debt, known as gearing, to enhance returns. Net gearing - bank borrowing minus cash - was 4 per cent at the end of December. However, the trust uses derivatives, and net gearing plus synthetic gearing is 12.1 per cent.

The trust will also invest in equities, for example, if a company's share offers a higher yield than its bond. These accounted for nearly 5 per cent of assets at the end of December.

Areas Mr Patullo and his team don't like cyclicals that don't offer much top-line growth. However, this means that in bull markets the trust may lag.

The trust recently increased its holdings in high yield and investment grade bonds. Mr Patullo says that the default environment is supportive for corporate bond investing and should be for years. He anticipates low growth, low inflation, low volatility and low defaults, and also points out that high-yield defaults have been low.

Mr Patullo says financials have been a great contributor to performance and likes long-dated insurance bonds because they were cheap to buy. Top issuers in this area at the end of December included Scottish Widows, accounting for 1.9 per cent of assets, and AXA, accounting for 1.7 per cent.

Risks for the trust include default, and currency as not all of its assets are in sterling. "We won't hold more sterling assets because we don't want rubbishy UK retailers," says Mr Patullo.

Other risks include Federal Reserve aggression leading to unhinged rate expectations, and investors leveraging up to maximise returns or stretching for yield and investing in illiquid assets.

He has also positioned the trust for further convergence of fixed and mobile telecoms companies, where mergers and acquisitions (M&A) activity is being driven by factors including structurally challenged mobile only players and exponential data growth.

"High-yield companies can see their bonds experience significant capital appreciation if acquired by an investment grade company," he says.

Top ten holdings at the end of December in the telecoms area included Wind which accounted for 1.5 per cent of assets.

Source: Morningstar & *Henderson

Share price performance

Source: Morningstar, as at 21 January 2015

Top 10 issuers, as at 31 December 2014

Asset allocation (%)