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Retire on investment trust income

Investment trusts' reliable dividend payouts can make them a useful part of a retirement income portfolio
August 13, 2015

Over the past few years the number of investment trusts paying quarterly dividends has increased, with 118 out of more than 400 investment companies paying a quarterly dividend, according to a recent survey by QuotedData. Meanwhile, five investment trusts pay a monthly dividend, in contrast to only one 18 months ago. These are: *F&C Commercial Property (FCPT), Fair Oaks Income (FAIR), SQN Asset Finance Income (SQN), TwentyFour Select Monthly Income (SMIF) and Ediston Property Investment Company (EPIC).

This comes at the same time as a massive shake-up in the pensions landscape, meaning that an annuity is no longer the only option for many retirees. "Now that the norm is to pay dividends more frequently we see investment trusts as a valuable contender for those looking for a regular income, including retirees or those approaching retirement," says Matthew Read, senior investment analyst at QuotedData. "And with attractive levels of income typically ranging between 4 and 8 per cent, and in some cases up to 10 per cent, offered by these frequent dividend-paying investment trusts, it's clear to see why they have attracted income-hungry investors."

You could construct a portfolio to pay you every month. David Liddell, director at investment adviser IpsoFacto Investor, suggests the following portfolio for a yield of around 4 per cent and 12 annual monthly income payments, without having to erode the capital by selling shares.

 

IpsoFacto monthly payout portfolio

Fund% of portfolioYield (%)1-year share price return (%)3-year cumulative share price return (%)5-year cumulative share price return (%)Discount/premium to NAV (%)
JPMorgan European Income (JETI)53.52288100-1
Investors Capital Unit (ICTU)12.54.784454-7.2
Edinburgh (EDIN)103.41949114-2.5
Temple Bar (TMPL)103.403776-4.4
Aberdeen Asian Income (AIIF)54.6-7148+1.5
iShares FTSE 100 Dividend (IUKD)*154.414nanana
Murray International (MYI)12.55.1-11028+1.4
Acencia Debt Strategies (ACD)12.53.634566+43.4
BlackRock Commodities Income (BRCI)58.7-35-29-28+5.9
London & St Lawrence (LSLI)12.54.1-14471-7.4

Source: IpsoFacto Investor, Winterflood & *Morningstar, as at 6 August 2015

 

"We think this portfolio would be attractive for those with pension pots between £50,000 and £200,000 who want to take control of their investments to generate an income, while also having a reasonable chance of capital growth," he says. "It would also work for savings outside a pension pot such as individual savings accounts (Isas)."

There are other reasons why investment trusts can be a useful part of an income portfolio in retirement.

Investment trusts can smooth their income payments because they can retain up to 15 per cent of the income they receive and build up a reserve, and offshore domiciled investment companies have no limit on the income they can hold back. This means that in years when their investments don't pay such a good level of dividends the reserve can be used to plug the gap.

For example, Merchants Trust (MRCH) suffered from a dividend cut at BP (BP.) in 2010 and the major banks after the financial crisis but was able to maintain dividend growth by dipping into its dividend reserve. Its manager also generated some additional revenue with option writing (covered calls).

Some of the older trusts have built up revenue reserves in excess of one year's dividends. Examples include Temple Bar (TMPL) and Edinburgh Investment Trust (EDIN).

Investment trusts can also pay dividends out of capital, although at present most trusts don't take advantage of this ability. Trusts that do this include *Personal Assets Trust (PNL) and *European Assets (EAT).

Keep your options open

Jason Hollands, managing director at Tilney Bestinvest, says: "If you want a portfolio for retirement income you should hold investment trusts alongside other investments, looking at what is attractive. Never approach building a portfolio restricting yourself to one type of investment: selecting investments is a challenge anyway because there are so many poor performers. But if you can find an investment trust with a good fund manager, good track record and a payout schedule that works for you, then it is worth inclusion."

But don't be tied to the payout schedule: an investment trust that pays out once or twice a year with a reliable record is probably a better option than one that pays out four times a year but is less reliable. You could take a payout from one with less frequent payouts and not spend it all at once.

"You should never buy higher-risk assets if you are not sure of the quality just because the trust pays monthly or quarterly," warns Mr Hollands.

Many equities with an attractive income are on high valuations at the moment and investment trusts with attractive yields - for example, in the infrastructure sector - are on high premiums to net asset value (NAV).

"You should not buy at excessive premiums," advises Mr Hollands. "But a small premium may be worth paying for because the level of yield is so attractive and the underlying asset class is not readily accessible. An example is infrastructure, but because of the high premiums on these you should try and get in when they do new issues."

When investment trusts issue shares it can offer an opportunity to get in at a lower premium to NAV.

Mr Hollands says that you should also see how the premium or discount on a trust compares with its long-term history.

Investment trusts can take on debt, known as gearing. Having more money to invest can boost profits when markets are rising, but if they fall the trust can incur losses and may have to cut its dividends.

Shires Income (SHRS), for example, was heavily geared during the financial crisis and managed to maintain its dividend in 2009, but because of a reduction in revenue income it cut the dividend the following year.

Investment trusts offer few options for investing in bonds, unlike open-ended funds. While advisers are not keen on bond funds at the moment this might change in the future.

Mr Liddell says if you want to focus on listed funds you should also consider exchange traded funds (ETFs) as these widen your investment universe and give more fixed income options.

 

Constructing your portfolio

It is important to generate enough income to give you a good quality of life without taking too much from your retirement pot too quickly and leaving yourself short during the last years of your life. Some of your portfolio needs to be held in riskier assets to give you growth rather than lower volatility ones. The right mix of investments should be tailored depending on your age and health, which are good indicators of how long you have left to live.

Mr Hollands says retirees need to weigh up the balance between the need for an immediate income payout and the prospects for a growing level of dividend. "It is important to assess the potential for dividend growth over time unless you are very elderly," he says. "The risk is that the growth in distributions will not match inflation, so an investment trust's ability to grow dividends over time, even if you start with a lower yield today, is important."

So don't just look for what currently has the highest yield.

James Carthew, research director at QuotedData, says you should have an idea of how much income you want, and aim for a yield on your portfolio that is achievable. He says at the moment 4 per cent is realistic, or 5 per cent if you are prepared to take on more risk.

Mr Liddell adds that you should consider your income drawdown portfolio in the context of all your assets and make sure they work together for your circumstances.

Mr Carthew says it is important to have a spread of investments and variation in the underlying asset class so, for example, if there are problems with UK equity income, you are not wholly exposed to this area. If you have a number of trusts even if one cuts its dividends your overall portfolio should not be too badly affected.

 

Choosing a trust

When choosing an investment trust for an income portfolio in retirement look at its dividend history to see if it been a consistent payer. Trusts' websites and annual reports may have this information, as well as data providers such as morningstar.co.uk

The Association of Investment Companies (AIC) publishes an annual list of the investment trusts that have the longest records of increasing their dividends every year.

You should also look at what a trust's dividend policy is and how much it has in its revenue reserves. And check the trust's dividend cover - the number of times its most recent dividend can be paid out of its annual earnings. You can check the dividend cover ratio on websites such as QuotedData.

Performance is also a consideration, because there is no point investing in a trust paying good dividends if it is losing capital.

Colin Low, chartered financial planner at Kingsfleet Wealth, favours funds with consistency of return. "Don't look at the three- and five-year cumulative total returns in isolation," he says. "It can be better to look at the discrete performance and not necessarily go for the ones that are top quartile but are consistent, and on which the yield has not varied dramatically. An initially high yield can be a value trap."

Mr Hollands suggests Standard Life Equity Income Trust (SLET), which takes a multi-cap investment approach unlike many equity income funds which focus on blue chips. Just over 45 per cent of its assets are in mid caps, with a third in FTSE 100 shares. Manager Thomas Moore also tries to avoid companies that are at risk of dividend cuts.

The trust yields 3 per cent and trades at a discount to NAV of 0.5 per cent

Mr Hollands also suggests Keystone Investment Trust (KIT). "Its manager, Mark Barnett, takes a conservative and multi-cap approach, although Keystone is large-cap focused and has more of a skew to defensive large companies in sectors such as tobacco and pharmaceuticals," he says.

The trust yields 2.8 per cent and be picked up on a discount to NAV of 6.4 per cent, wider than its 12-month average of 5.9 per cent.

Investors with a higher risk appetite could consider Asian equity income trusts, which offer relatively high yields at the moment because the area is unloved.

 

Performance of Asian equity income trusts

TrustYield (%)1-year share price return (%)3-year share price cumulative return (%)5-year share price cumulative return (%)Premium to NAV (%)Ongoing charge (%)
Aberdeen Asian Income (AAIF)4.6-7148+1.51.25
Henderson Far East Income (HFEL)6.2-12130+3.61.21
Schroder Oriental Income (SOI)4.142970+2.11.34
MSCI AC Asia Pacific ex Japan-11726

Source: Winterflood, as at 6 August 2015

 

Securities Trust of Scotland (STS), meanwhile, has just amended its articles to enable it to take dividends from capital and is aiming for a yield in excess of 4 per cent.

Mr Low suggests Finsbury Growth & Income* as it has a consistent record (FGT).

*IC Top 100 Funds

 

Performance of recommended trusts

TrustYield (%)1-year share price return (%)3-year cumulative share price return (%)5-year cumulative share price return (%)Discount/premium to NAV (%)Ongoing charge (%)
Finsbury Growth & Income22372130+1.30.82
Keystone Investment2.81060102-6.41.27
Securities Trust of Scotland3.9-21668-5.60.55
Standard Life Equity Income3.1209294-0.50.95
FTSE All-Share73657
FTSE 350 High Yield02554

Source: Winterflood, as at 6 August 2015