Income with lower risk at CQS New City High Yield

The IC Top 100 Fund offers an appealing high income stream at a time when rates are - for now - keeping a lid on yields. The trust invests in high-yielding fixed-interest securities including company debt, government debt and preference shares. But unlike other similar high income trusts, it is able to invest up to 100 per cent of total assets in any one type of fixed-income security.

CQS New City High Yield offers one of the highest yields in its sector, and also aims to preserve capital. The trust's yield currently stands at 7.7 per cent and the trust has increased its dividend for nine consecutive years. This year management adjusted the dividend policy in order to reduce the gap between the three interim dividends, previously paid at the same time, and larger final dividend. The payout of 4.31p for the year ended June 2015 was a 2.4 per cent increase on the previous year.

According to Monica Tepes, an analyst at Cantor Fitzgerald, it has also succeeded in preserving capital and delivering lower risk. She says: "Since inception in 2004, the fund has delivered stronger returns than the FTSE All-Share index with a much higher yield and significantly lower volatility." The trust's net asset value (NAV) lost 22.2 per cent in its worst peak-to-trough total return compared with a drop of 45.6 per cent for the FTSE All-Share and the annualised volatility of the trust's NAV returns are lower than peer trusts City Merchants High Yield and Henderson High Income by some way.

However, the trust's share price and NAV returns have not kept pace with the Association of Investment Comapnies (AIC) UK Equity and Bond Income sector over the short term. It has returned less over one, three and five years. Despite that, the trust generated positive returns in every calendar year since 2008 until the year to date, in line with its absolute return approach.

Craig Cleland, head of corporate development, investment trusts at CQS, puts the short-term underperformance down to worries over the timing of a US interest rate rise, which has affected the value of high-yield stocks. He says: "We continue to hold these stocks and firmly believe they will repay at par value when they mature in two or three years' time. So this is a short-term hit to the portfolio on market worries but we think these will recover over the next year or two. The market in preference shares has also been volatile following tax changes in the Budget."

Investors piled into junk bonds when they felt an interest rate rise was still far off but the market has been volatile, with jitters over the timing of a hike making it a tricky market to navigate. Rising rates will prove the biggest risk for the high-yield market as it increases the cost of borrowing. But that is where the benefits of investing in a trust, which holds back revenue reserves, comes in, and a trust with lower exposure to the securities most hit by a rate rise is even better.

Ms Tepes says: "Higher-yielding bonds generally have a lower duration (due to shorter maturities, higher coupons) and therefore lower interest rate risk compared with investment grade bonds. The portfolio also has a degree of inflation protection directly through floating rate notes and indirectly through convertibles/equity and non-sterling exposure."

The trust currently has 24 per cent invested in covertibles, equities and preference shares, with 18 per cent of that invested in equities and 3.5 per cent in floating rate note securities. CQS New City High Yield also comes with the benefit of a revenue reserve, which it has said it will dip into if necessary to pay out dividends. The trust currently has a dividend cover of 105 per cent and revenue reserves of 4.24p a share. That means that on top of adding to its revenue reserve from the previous year, it has enough to pay out almost a year's worth of current dividend in its coffers, providing a healthy buffer to shareholders.

It could also be a good time to gain access to the trust as its current premium, at 3.36 per cent is smaller than its 12-month average, 4.26 per cent. Buy.

Source: Morningstar, as at 3.11.15

Share price and NAV cumulative returns

Source: Morningstar, data cumulative to 3.11.15

Top 10 holdings

Source: Morningstar, as at 30 September 2015

Sector allocation

Source: As at 30 June 2015, NCIM annual report 2015