Two investment trust for income portfolios

Mr Liddell's portfolio performance

Mr Liddell originally said: "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. It would also work for savings outside a pension pot, such as individual savings accounts (Isas)."

The portfolio is so far doing its job - generating income as well as preserving the capital in the pot. From the beginning of April, when Mr Liddell launched the portfolio, to 9 October 2015 the income generated has been about 2.85 per cent and over that period the capital performance has been pretty much in line with the FTSE 100. The yield annualised on this basis would be around 4.5 per cent.

The highest-paying trusts so far

Putting together an income-paying portfolio is a tricky balancing act because trusts usually pay quarterly or twice yearly dividends. One way to work around that is to harmonise your choices so that each month at least one trust pays out income.

The trusts in this portfolio (which also includes one exchange-traded fund) have not yet had a full year to pay out income. So far, the trust paying out the most in income has been Murray International Trust (MYI). It has paid out 36p in dividends so far, higher than the majority of the trusts in the group. It is also on one of the highest yields, at 5.7 per cent, having raised its dividend by almost 8 per cent over five years. The global trust has had a nail-biting time recently, falling to its first discount in five years in August. That followed disappointing interim results for the first six months of 2015, which revealed that its share price and net asset value (NAV) had both dropped against the benchmark. But the trust has consistently paid out high dividends from its fund of global equities and has been compensating investors for its falling share price with a very solid income stream.

David Liddell's portfolio

Dividend payments (p) since May

Source: IpsoFacto Investor, as at 12.10.15

Another trust delivering a good income has been Temple Bar Investment Trust (TMPL). The company moved to a rare discount of more than 5 per cent in April after failing to beat its sector average and the FTSE All-Share over a year, but over the long term performance has been good and the trust has increased its dividend for 31 consecutive years. In 2014 it paid out a 38.88p dividend, an increase of 3 per cent on the previous year.

Two other notable dividend payers are Investors Capital Units (ICTU) and Edinburgh Investment Trust (EDIN).

ICTU is a dividend-focused fund that invests in a mixture of bonds and equities to deliver a high yield.

Edinburgh is a company formerly run by renowned manager Neil Woodford. Now managed by Mark Barnett, the trust aims to deliver capital growth exceeding the FTSE All-Share, balanced with dividend growth beating UK inflation from a basket of UK stocks. With inflation at record lows, that is not a tricky task at the moment, but the trust's final dividend of 8.60p paid out in July meant it has so far generated 13p for the portfolio. Mr Liddell says: "I think there is a good stockpicker at the helm there and I like the trust as a slightly more defensive balance against some of the rest of the portfolio."

Simon Moore, head of research at Tilney Bestinvest, says: "Mark Barnett has had a successful first year at the helm following his appointment as Neil Woodford's successor in early 2014. Mr Barnett has reduced the high stock and sector weightings favoured by Mr Woodford, but still has a bias towards healthcare stocks, including GlaxoSmithKline and AstraZeneca."

Future income payers and dividend protectors

But income isn't all about the here and now. Closed-ended funds have a key benefit over open-ended vehicles in their ability to hold back some revenue to pay dividends in the future. Trusts can behave in many ways like an ordinary company and protect shareholders against future risks by putting away some cash for a rainy day.

Some trusts are also able to pay dividends out of capital, reducing the need for reserves. But most tend not to, so dividend cover is a good place to look if you are worried about the sustainability of your income.

Two trusts well known for their revenue reserves are Temple Bar (TMPL) and Edinburgh Investment Trust (EDIN). These are older trusts and, along with Aberdeen Asian Income Fund (AAIF) have by far the largest reserves of the trusts in the portfolio and the largest dividend cover ratios (a ratio of a company's net income over the dividend paid to shareholders).

By contrast, JPMorgan European Trust (JETI) is designed mainly for capital growth, but does have an income share class, which now pays out quarterly dividends. With reserves of just £1.5m and dividend cover of 0.4 it does not have considerable buffers to protect it if it hits difficulties.

Past and future dividends of investment trusts in the portfolio

Source: Quoted Data, as at 13.10.15

*Source: The Association of Investment Companies, as at 14.10.15

**Acencia did not pay dividends in 2010, making a large percentage jump in dividends over five years

Income versus capital growth - is it a choice?

Investors putting together a long-term income portfolio cannot afford to focus only on income. You will need your trusts to appreciate and deliver total returns unless you want to risk eating away at your capital.

Some trusts look appealing when it comes to yield. But a high yield can signal that the price of a trust has fallen dramatically and implies higher risk as well as higher income. That is certainly the case with BlackRock Commodities Income (BRCI). The fund has by far the highest yield in the group, at 10.6 per cent. But its share price has plummeted this year amid the wider drop in global commodity prices, linked to the Chinese slowdown. In the summer, commodity prices reached their lowest level since the financial crisis and the BlackRock trust followed suit, plumbing new depths in September before rallying this month.

Mr Liddell said he still likes the trust: "It is down 18 per cent from the beginning of April to 9 October, but that mirrors what's happening in a lot of the mining and commodity stocks. The yield on Rio Tinto is 6 per cent, that's telling you that people expect the dividend to be cut. But other than Glencore a lot of the companies are still saying that they will hold their dividends," he says.

"My view is that it's a good time to be in BlackRock Commodities Income. We've had quite a strong recovery from the bottom in the middle of September and Rio Tinto is probably up 10 per cent from the end of August and beginning of Sept so there's been quite an underlying recovery there. I would still buy it today on the expectation that the dividend might be cut by a third."

Murray International Trust is another trust whose share price has taken a beating at the hands of currency fluctuations and due to manager Mr Stout's bet on emerging and Latin American markets.

Mr Liddell says: "Murray International is a very interesting trust and had a tremendous long-term record. Bruce Stout is a very successful manager but has been in the wrong place over the past two or three years. In particular, Brazilian and emerging markets exposure has hurt the fund. But I still like it as a contrarian play and the yield is good. It's also got revenue reserves so should be ok.

"I think the criticism one would make perhaps is that he just went too far looking for value outside the areas of QE. But I still think he is a good stockpicker," he says.

Share price performance (cumulative total returns %)

Source: FE Trustnet, as at 12.10.15

Other income trust suggestions

Tilney Bestinvest's Simon Moore has put together a portfolio of investment trusts for income. It is another 10-trust portfolio and is highly diversified by sector and region, including UK equities via a large holding in Edinburgh Investment Trust but also emerging markets, Asia, frontier markets and several trusts deriving income from property, asset-backed securities and high-yield bonds.

The companies focused on equities include JPMorgan Global Emerging Markets Income (JEMI), currently on a 4.25 per cent discount. Mr Moore says: "Beating the benchmark has proved to be challenging recently, but the fund is still in positive territory in absolute terms."

He has also chosen Henderson Far East Income (HFEL), an Asia Pacific ex Japan equity trust. Henderson's share price return has delivered almost double Aberdeen Asian Income (AAIF) over five years, but in the short term has underperformed it. Henderson's dividends have also been higher than Aberdeen's and Mr Moore believes investors are now "turning to Asia for income".

The diversification elements of the portfolio include trusts such as TwentyFour Income (TFIF), an investment company specialising in asset-backed securities. The trust is a form of fixed-income fund, but invests mainly in debt securities backed by European residential mortgages. It has a good income stream and behaves differently to other elements of the portfolio.

Simon Moore's portfolio

Source: Tilney Bestinvest, as at 13 October 2015

See also:

Top trusts

The professional picks for 2015

Making better use of global trusts

Around the world in 8 investment trusts

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