Two investment trust portfolios for income one year on

The two portfolios were created by David Liddell, chief executive of online investment service IpsoFacto Investor, who put together his portfolio two years ago, and Simon Moore, head of research at consultancy Trust Research, who put together his portfolio last year. Mr Liddell's portfolio was designed to pay out a monthly income from a mixture of UK and international funds. Mr Moore's portfolio has a high allocation to a single trust, Edinburgh Investment Trust (EDIN), and a greater number of investment trusts focused on emerging markets, Asia and frontier markets - as well as some exposure to fixed income.

Of the two portfolios, Mr Liddell's has delivered a higher total return - 16.3 per cent compared with 9.9 per cent - but the individual trusts within Mr Moore's portfolio have been better income generators and grown more in capital terms, too. Mr Moore's large overweight position to Edinburgh Investment Trust, which he has allocated 45 per cent of his portfolio to, explains his portfolio's underperformance in total return terms against Mr Liddell's.

David Liddell's portfolio

Mr Liddell's portfolio yields around 4.8 per cent. "Originally, this portfolio was put together to pay out monthly income and I was aiming for a 4 per cent yield," he says. "Within that I wanted it to be as diversified as possible and take advantage of trusts that looked cheap at the time."

Three of those cheap trusts which were the best generators of income between the end of September 2015 and 2016 included Blackrock Commodities Income (BRCI), Murray International Trust (MYI) and Aberdeen Asian Income Fund (AAIF). If an investor had put £10,000 into each of those at the start of that period, they would have earned over £400 in income during the year. Blackrock Commodities Income, which yields over 6 per cent, paid out the most by far and generated £786.03 on an investment of £10,000 over that period.

However, the 2014 and 2015 commodities rout means its share price has taken a beating and its total returns have not been impressive. In 2015, the trust lost 32.9 per cent and over five years 7.3 per cent.

The trust is also lowering its 2016 dividend target from 6p to 5p, resulting in the prospective 2016 yield falling from 6.9 per cent to 5.2 per cent. It stated that it planned to use revenue reserves to pay that if income alone was insufficient. The trust's dividends were not covered by its reserves at the time of writing last October and its first two 2016 dividends were not covered by revenue return. However, Mr Liddell says the outlook for the trust is more secure now due to the rebound in commodities and better company fundamentals.

"You don't get that yield without taking some risk, but the cash flow of the underlying investments should now be reasonably secure because of the cuts in capital expenditure by mining companies since 2015," he says. "If we go into another commodity price crash then that will be a problem, but if we are moving more into an inflationary cycle then the price of commodities will rise and this trust will do well."

Murray International is also experiencing a reversal in fortunes after two years of disappointing performance and is the second-highest income-generator of Mr Liddell's trusts. The former top-performer, which is managed by Bruce Stout, had fallen to its first discount in five years when Mr Liddell selected it for his portfolio last year, but is now performing better as a result of weaker sterling.

Over the period analysed, the trust would have thrown off £438.76 of income on an initial investment of £10,000 and it was the best performer in total return terms too with 45.3 per cent between 30 September 2015 and 2016.

The trust has stormed ahead since January, beating the Association of Investment Companies (AIC) Global Equity Income sector average by more than 20 per cent since the start of the year. While sterling has been the key contributor to performance, positions which previously weighed on returns, including exposure to Latin American equities, emerging market debt and value-orientated stocks have recently caused it to outperform.

Aberdeen Asian Income Fund was also chosen when it was at a discount and over the long term has delivered consistent dividends which have been well covered by its reserves.

"We looked at Aberdeen Asian Income because at the time you could buy it on a good discount, Asian markets were depressed at the time due to concerns about China and it looked like a reasonable recovery play again with a nice yield," says Mr Liddell.

Simon Moore’s best income-payers

Over the year to October 2016, SQN Asset Finance Income Fund (SQN), Henderson Far East Income (HFEL) and Invesco Perpetual Enhanced Income (IPE) have generated the most in income alone. However, the trusts in Mr Moore's portfolio have all performed well in income terms - the majority would have generated more than £400 in income from a £10,000 initial investment between September 2015 and 2016.

The majority have also delivered good capital growth, with several including JPMorgan Global Emerging Markets Income (JEMI), Henderson Far East Income and Blackrock Frontiers (BRFI) generating a total return of more than 30 per cent in a year. That is symptomatic of the relatively higher risk of Mr Moore's portfolio, which is more concentrated in emerging, Asian and frontier markets, which after several years of severe underperformance have trumped developed market equities this year.

Like Aberdeen Asian Income Fund, Henderson Far East Income has soared since the start of the year. Historically, Asian companies have not demonstrated good payout ratios, but this is improving in many emerging Asian markets such as the Philippines and South Korea. Meanwhile, Asia also includes developed markets like Australia, where profitable, well-run companies with good dividend streams are listed.

Henderson Far East Income has 20.9 per cent of its assets in Australia and a large chunk of its portfolio in financials - 31.7 per cent - making it slightly higher risk than other Asian income options.

Over 10 years, the trust in the portfolios with the best total return is Edinburgh Investment Trust, which has returned 152.9 per cent compared to its benchmark, the FTSE All-Share, which returned just over 70 per cent. Edinburgh Investment Trust features in both the portfolios.

It was taken over by Mark Barnett in 2014 and has been performing well since then. Although it has not topped other trusts in terms of income, it has a solid track record of increasing dividends each year above inflation.

The trust aims to deliver capital growth exceeding the FTSE All-Share, balanced with dividend growth-beating UK inflation by investing in UK stocks. Mr Barnett has been bearish on the outlook for the UK economy and so tends to hold quality, cash-generative businesses with the ability to grow earnings.

The safest sources of income (dividend cover)

A key benefit of investing in investment trusts is their ability to hold back 15 per cent of earnings each year. This enables them to pay a consistent dividend stream to shareholders even if the companies they hold cut their dividends.

Trusts cover the dividends through earnings primarily, so low revenue reserves are not necessarily a cause for concern. But it does mean that the current level of dividend could be unsustainable if the trust's income falls due to dividend cuts within its portfolio.

The trust in both portfolios with the highest revenue reserves is Invesco Perpetual Enhanced Income, according to Morningstar. The trust's 2015 dividend was covered 1.91 times by its revenue reserves.

Invesco Perpetual Enhanced Income has built up its large revenue reserve pot - £12.89m at the end of its last financial year - over a long time period as it was launched in 1999. During its last financial year, it generated revenue return of 4.9p per share, just short of the 5p dividend for the year, meaning that although it did dip into reserves, it retains a healthy buffer if it hits harder times.

Temple Bar (TMPL) and Edinburgh Investment Trust are also well known for paying out dividends over the long term and are older trusts, too, meaning they have built up good reserves. Last year they were top of the table in terms of dividend cover and both have remained near the top, but in both the cases dividends are looking less well covered by reserves than they were a year ago.

Last year, Edinburgh's dividend was covered 1.4 times by its reserves, but this year that has fallen to 1.3 times. Temple Bar was covered 1.3 times by reserves but this has fallen to 1.1 times. However, both the trusts increased their dividends in their last financial year. Edinburgh increased dividends by 2.1 per cent on its previous year and Temple Bar increased its annual dividend payment for the thirty second consecutive year, raising it by 2 per cent.

At the other end of the scale, JPMorgan European (JETI) remains at the bottom of the pile. The trust was designed mainly for capital growth, but has an income share class which pays out quarterly dividends. It is only covered 0.37 times by its £1.63m revenue reserve.

Blackrock Commodities Income has a high yield, raising questions about whether it will be able to maintain its high payouts with relatively low reserves, which cover its previous year's dividend of just 0.38 times.

The trust pays income out of reserves as well as out of capital - something trusts have been able to do since 2012. Throughout 2015 it was forced to reduce exposure to companies such as Freeport (FCX:NYQ), Vale (VALE5:SAO) and Antofagasta (ANTO) due to fears over dividend cuts.

Of the trusts in the two portfolios, SQN Asset Finance Income Fund¸ which earns revenue by leasing business-critical machinery to large companies, has the lowest level of revenue reserve as a proportion of its annual dividend payment. This is partly because it only launched in 2014 and also because its dividends are very high. It has paid out the most income of all Mr Moore's trusts.

This trust is domiciled in Guernsey and so has always had the ability to pay dividends out of capital.

Mr Moore says: "SQN should remain uncorrelated with the performance of other trusts in the portfolio."

The trusts likely to outperform

Mr Liddell anticipates that value-orientated managers such as Bruce Stout and Alastair Mundy, who runs Temple Bar Investment Trust, could do well this year.

He says: "The value style generally has been out of favour over the past five years but there is a good chance that we will get US rates going up and that the bond proxies might fall out of favour a bit, as well as the momentum stocks which have become expensive, and that should play to value outperforming."

Temple Bar has underperformed the FTSE All Share recently. It has been managed quite cautiously, and has exposure to financials and oil stocks which have at least until recently been quite weak, but it hasn't benefited from so called bond proxies, which have been doing well.

But Mr Liddell says: "I think the trust has a good ability to take advantage of any equity weakness and increase its dividends reasonably well from here."

Alan Brierley, director, investment companies team at Canaccord Genuity, adds: "Alastair Mundy has a distinct value-orientated contrarian philosophy, where he will look to buy into uncertainty when pessimism is high and valuations low. The manager believes that the most predictable behavioural response of investors is their over-reaction to negative news. We like the contrarian style which is unique in the UK Equity Income closed-end sector and as such we believe it has an important role in improving diversification; we maintain our long-standing buy recommendation."

Mr Liddell also thinks that London & St Lawrence (LSLI) has good prospects. "This is a long-standing conservatively-run trust that invests in other investment trusts, its dividend has been reasonably good in terms of rises over the past five years, and because of its exposure to investment trusts that should be reasonably secure in terms of how the income is managed," says Mr Liddell.

Mr Moore says UK income investors are often blinkered by looking only at the UK for income, and should increasingly look to Asian countries and emerging markets for this. With that in mind, he is reducing his weighting to Edinburgh Investment Trust and rebalancing the portfolio towards global equities.

He says he has been disappointed with the performance of Edinburgh in recent months, but has faith in Mr Barnett's ability to outperform this year. "Since taking over the trust, Mark Barnett has reduced exposure to GlaxoSmithKline (GSK), reduced some of the small-cap names and is looking more at the unlisted portfolio," he adds. "You do need some UK exposure and for UK equity income he's your best man."

David Liddell's portfolio and performance

Source: FE Analytics, as at 11.10.16

*Total return adjusted to account for trust's weight in portfolio, to reflect the return experienced as an investor in the portfolio

Simon Moore's portfolio and performance

Source: FE Analytics, as at 11.10.16

 *Total return adjusted to account for trust's weight in portfolio, to reflect the return experienced as an investor in the portfolio

Income earned on portfolio between 30.09.15-30.09.16 on £10,000 invested (assuming same amount invested in each)

Source: FE Analytics, as at 11.10.16 (income earned based on how many shares you would buy on that day, and the dividend per share)

Long-term total returns of portfolios and current yields: David Liddell portfolio

Source: FE Analytics, as at 11.10.16 *Morningstar, as at 19.10.16

Long-term total returns of portfolios and current yields: Simon Moore portfolio

Source: FE Analytics, as at 11.10.16 *Morningstar, as at 19.10.16