Join our community of smart investors
OPINION

In a world of rising yields investors need to check for cover

In a world of rising yields investors need to check for cover
January 21, 2016
In a world of rising yields investors need to check for cover

While investment trust shares have not been immune from the steep market falls experienced so far this year, a total of 21 trusts now yield above 4 per cent, according to data from Stifel Funds.

But with commodity payouts either getting cut or looking increasingly shaky, how secure are these levels of shareholder payouts?

 

Attractive yields

In yield terms, now looks like a great time to take home healthy income from investment trusts at wide discounts - only five of the 21 trusts highlighted by Stifel are trading at a premium to net asset value and all are yielding from 4 per cent to 12.9 per cent, in the case of BlackRock World Mining, whose shares are on a 12.5 per cent discount.

Other high-yielding trusts include BlackRock's Latin American vehicle, which yields 7.9 per cent and whose shares trade at a 10.2 per cent discount at present, while the Henderson Far East Income trust is on a 2 per cent discount and offers a 7.4 per cent yield.

But companies across the FTSE 100 and sectors such as mining and oil and gas are under threat from dividend cuts, calling into question the high incomes paid out by trusts too. Last year Glencore scrapped its dividend in order to reduce debt and investors are feeling nervous about a number of stocks where dividends are looking shaky in light of lower company earnings.

Investors are increasingly worried about BHP Billiton, whose shares have tumbled in recent days due to fears of a dividend cut. In December the stock was yielding 10.9 per cent but its payout was covered only 0.4 times by earnings, according to AJ Bell. Rio Tinto is in a similar situation, yielding 7.9 per cent but covered only once by earnings at the end of last year.

 

Domino effect

That problem will be passed onto trusts, which are being forced to dip into their revenue reserves or capital in order to continue paying out to shareholders. In 2015, BlackRock World Mining's board said it was planning to raid its revenue reserves in order to maintain its dividend.

Chairman Anthony Lea said at the time: "Future use of reserves will depend on the board's confidence in returning to a fully covered position in the near term.

"Given the widespread challenges facing the mining sector, the sustainability of dividends at the underlying stock level is being closely monitored to determine your company's appropriate dividend payments for the future."

The structure of investment trusts, which can hold back revenue to pay dividends and have cover payouts with profits, means they are able to protect investors but some are safer than others.

  

Look for cover

Of the 21 high-yielding trusts, dividends in the majority are looking well covered by reserves, with many boasting a dividend cover of at least once times current reserves. Among the least protected are BlackRock North American fund, covered just 0.41 times, and BlackRock Frontiers, covered just 0.53 times.

The fact trusts can use both earnings and dip into reserves partly negates the need for high dividend cover by etiher reserves or earnings alone, but both remain important.

Ewan Lovett-Turner, director of investment companies research at Numis, says: "You want to see a combination of revenue reserve and dividend cover. There are some funds that pay out of capital but my preference is for full dividend cover. At the moment across the UK Equity Income sector, for example, dividends are typically between 1-1.2 times covered and revenue reserves are an average of more than half the year's dividends and I think that gives a good level of comfort."

 

Rainy day

The trust with the highest current revenue reserve, according to the Association of Investment Companies, is Murray International, holding £64.7m on its books, while BlackRock World Mining also maintains a reserve of £50.5m. At the bottom of the pile are North American Trust, with only £1.4m in reserves and Securities Trust of Scotland, with £3.2m.

However, offshore trusts, including Securities Trust of Scotland and European Assets (domiciled in the Netherlands) are able to pay income out of capital and are not subject to the same revenue rules as onshore trusts. The controversial move withdraws from the growth profile of the trust but managers argue it gives them greater flexibility to distribute more of their income to investors.

According to Mr Lovett-Turner, BlackRock World Mining is a "bit of a special case" and says it could be "one to watch over the next couple of years". He says a period of dividend cuts will test trusts but ultimately prove the benefits of the structure.

"Dividend cuts across the FTSE 100 are certainly a concern for underlying portfolio income in the UK Equity Income sectors but if we do get substantial cuts then you're the structural benefits of investment trusts will shine through," he says.

"You saw that in 2008 and 2009 where a lot of open-ended funds had to cut dividends in the face of dividend cuts in the market whereas investment trusts were more resilient."

But Stifel warns more trusts could face issues. It says "A small number of trusts may flag dividend cuts in the next few months."

Those under threat, according to analysts, include BlackRock World Mining, BlackRock Latin American due to its large exposure to Brazil, and JPMorgan Russian. The issue extends beyond the high yielders, too. In May 2015 popular trust Scottish Mortgage warned that depleting earnings from its stocks meant it was forced to dip into its revenue reserves and warned in the future the trust would face a choice between continuing to eat into its reserves or cutting its dividend.

 

Trust yields and discounts/ premiums

Investment trust Dividend yield Discount/premium
BlackRock World Mining (BRWM)12.9-7
BlackRock Latin American (BRLA) 7.9-10.2
Henderson Far East Income (HFEL)7.4-2
JPMorgan Global Emerging Income (JEMI)6.5-8
Murray International (MYI)6.2-1.9
Merchants (MRCH)6.1-1.6
European Assets (EAT)5.92.3
Aberdeen Asian Income (AAIF)5.9-7.2
Dunedin Income Growth 5.4-4.6
Henderson High Income5.32.9
Murray Income 5.2-6.4
Schroder Oriental Income4.9-4.3
JPMorgan Russian 4.8-9.5
Scottish American 4.54
Securities Trust of Scotland4.5-6.7
BlackRock Frontiers4.5-1.7
Schroder Income Growth 4.4-6
City of London 4.32.8
F&C Capital Income4.21.6
Henderson International 4-2
North American 4-8.7

Source: Stifel, as at 19 January 2016

 

Trust revenue reserves and dividend cover

Investment trust Revenue reserve (£m)Dividend cover (years)
BlackRock World Mining (BRWM)50.51.36
BlackRock Latin American (BRLA) 9.730.84
Henderson Far East Income (HFEL)19.640.89
JP Morgan Global Emerging Income (JEMI)10.170.7
Murray International (MYI)64.691.08
Merchants (MRCH)24.560.93
European Assets (EAT)0*0
Aberdeen Asian Income (AAIF)12.310.74
Dunedin Income Growth 22.631.31
Henderson High Income5.340.54
Murray Income 28.341.3
Schroder Oriental Income21.981.16
JPMorgan Russian 7.031.03
Scottish American 17.051.21
Securities Trust of Scotland3.220.56
BlackRock Frontiers4.990.53
Schroder Income Growth 7.231.04
City of London 38.360.78
F&C Capital Income10.081.05
Henderson International 2.410.67
North American 1.350.41

Source: The Association of Investment Companies, as at 15/12/15