IC income portfolios: 12 months on

The last 12 months have been a happy time for income investors. Equity dividends have already showed signs of recovery from the dark days of early 2020 while markets have stormed ahead. Many dividend hunters have enjoyed a combination of healthy payouts and substantial capital gains.

This shift in fortunes is amply reflected in the performance of our two investment trust income portfolios. The hypothetical £100,000 portfolios, put together by IpsoFacto Investor chief executive David Liddell and Simon Moore, director of the Trust Research consultancy, each generated a yield of more than 5 per cent between 1 October 2020 and 30 September 2021. Each portfolio also made a chunky capital gain, in stark contrast to the previous 12-month period that left them nursing paper losses.

As in our previous updates, we look at the holdings Liddell and Moore picked last year, the allocations different trusts and asset classes were given and how the portfolios fared over the 12-month period. We also ask how they are resetting their selections, and why.

How David Liddell’s portfolio performed

While Liddell diversified away from the UK market last year, his portfolio continues to take what some might see as a more traditional approach to income generation, with a heavy focus on shares. Some 82.5 per cent of portfolio assets sat in equity vehicles after last year’s reshuffle, with a quarter of the portfolio in UK equity income trusts. Liddell has also favoured various funds with a value bias – an approach that paid off nicely during the vaccine-led rally that took hold in November last year. Nine of the 10 holdings made share price total returns of more than 15 per cent from 1 October 2020 to 30 September 2021. The top performers, UK equity income names Edinburgh Investment Trust (EDIN) and Dunedin Income Growth (DIG), made share price total returns of 44.4 and 36.6 per cent, respectively.

The portfolio has done its job on the income front, slightly exceeding Liddell’s target of a 5 per cent yield. Six of the trusts in the portfolio exceeded that target on an individual basis, with the 6.4 per cent yield from Edinburgh leading the way.

It should also be noted that Murray International Trust (MYI) shares went ex-dividend on 1 October 2020, meaning the portfolio missed out on one of its four quarterly dividend payments simply due to the timing of our dates. The income from this trust would have been even greater, had we slightly adjusted the time period.

“The performance reflects the recovery and vaccine programmes,” Liddell notes of the broad returns. “When we looked last year we weren’t yet into the vaccination stage and people didn’t know how that would go. Equity markets were still pretty cheap, even though there had been a recovery from the lows of March 2020.”

As with many a portfolio, there remains a weak link. JLEN Environmental Assets (JLEN), the only holding with no focus on the equity market, was down by 2 per cent in terms of share price total return, even if it did generate a good level of income. Liddell suspects it may be out of favour among investors as its assets “seem to be a bit short life”.

David Liddell’s portfolio changes

As Liddell sees it, there is good reason to exercise caution this time around. “Last year we thought equities were very cheap and we had a good bounceback. Now there are many uncertainties facing us, not least that we’re not out of the Covid woods yet,” he explains.

He is therefore reducing the portfolio’s exposure to equities while also moderating his yield target from 5 to 4.5 per cent. “It’s tough to go for 5 per cent again when equity markets have gone up by 25 per cent,” he says. “If one tries to de-risk a little bit from equities, the buying yield needs to fall a little.”

This year’s reshuffle involves selling the portfolio’s best two performers on the back of a strong run. Liddell notes that Edinburgh “very much did its job and more”, bouncing back aggressively in terms of share price performance while also paying out more income than expected thanks to a special dividend, with Dunedin Income Growth also performing well. Both names exit the portfolio. JLEN Environmental Assets also goes, as does BlackRock World Mining Trust (BRWM), a name that made a share price total return of more than 30 per cent.

Liddell has found similar alternatives to some of these names. He has introduced UK equity income name Murray Income (MUT) as a partial replacement for Edinburgh and Dunedin Income Growth. While he believes these portfolios look “reasonably similar”, Liddell is interested in the fact that Murray Income shares recently traded at an unusually high discount compared with their recent history – something that might be attributed to shareholder “indigestion” after it absorbed the Perpetual Income & Growth Investment Trust last year. Murray Income shares traded on a 5.9 per cent discount to net asset value (NAV) on 25 October, compared with a 12-month average of 3.5 per cent on the same date.

Liddell also replaces the 7.5 per cent JLEN Environmental Assets weighting with a 12.5 per cent position in Renewables Infrastructure Group (TRIG) and switches out BlackRock World Mining Trust for a similar fund, BlackRock Energy and Resources Income (BERI). While BlackRock World Mining Trust has performed well, Liddell wants to go for a more diversified fund with a similar yield.

One other new addition enters the portfolio, in the form of M&G Credit Income (MGCI), which invests in both public and private debt. Liddell likes the underlying quality of the portfolio, noting that around 75 per cent of it is ranked as investment grade. “It’s a portfolio that looks like it might preserve capital more than some others,” he says.

He also cuts his exposure to North American Income Trust (NAIT) from 12.5 to 7.5 per cent of assets while upping the weighting on multi-asset fund Aberdeen Diversified Income and Growth Trust (ADIG) from 10 to 12.5 per cent. By changing some weightings, only directly replacing one of the dropped UK equity income trusts and introducing a debt fund, Liddell has cut his exposure to dedicated equity funds from 82.5 per cent of the portfolio to 67.5 per cent.

Murray International, JPMorgan European Income (JETI), Aberdeen Asian Income (AAIF) and CC Japan Income & Growth (CCJI) all stay in the portfolio at last year’s weightings. That said, readers should note upcoming changes at the JPMorgan trust, which has separate 'income' and 'growth' share classes. Under proposals that appear to have support from major shareholders, the two would merge, adopting the approach of the 'growth' shares. Under the new arrangement the trust would target a dividend of 4 per cent a year based on its NAV at the end of a preceding financial year.

Liddell argues that the change in approach could prevent the portfolio from depending on high-yielding stocks. That said, if the trust is effectively paying income out of capital this can bring its own problems in a market downturn.

Finally, it should be noted that Liddell has taken an interest in the music royalties trusts, arguing that they “have proved their case and provide a reasonable income”, and should be reasonably uncorrelated to equity markets. He has held off from adding them to the portfolio this time, in part because of concerns that such trusts might not add much in terms of capital appreciation, among other issues.

How Simon Moore’s portfolio performed

In a notable contrast to Liddell, Moore has tended to focus mainly on alternative asset classes that are either only available via investment trusts or best held in a closed-ended fund due to limited liquidity. The portfolio he created a year ago had an allocation of just 30 per cent to equities, with a quarter of its assets in property funds, another quarter in infrastructure trusts and the balance in loan and bond vehicles.

It’s worth noting how this has affected performance. In our last update we found that Moore’s portfolio had fared slightly better in a period of market volatility. This time around a strong recovery has rewarded both portfolios, with Liddell’s selection slightly ahead in terms of share price total return. Readers should note, however, that Moore’s portfolio generated a juicier yield of around 7 per cent.

Like Liddell, Moore has enjoyed positive total returns from almost all of his holdings, with 10 of the 11 trusts up for the 12 months. Collateralised loan obligation specialist Fair Oaks Income (FAIR) has had an unusually strong run: over the 12 months it delivered a 60 per cent total return, with an income that equated to a 25 per cent yield, eye-catching even against its history of high payouts. This may be explained by the fact that the shares were hit especially hard earlier in the pandemic, making the trust Moore’s weakest performer in our last update. By sticking with the trust back then, Moore has reaped the rewards of a substantial recovery.

Fair Oaks Income is not alone in driving portfolio performance, with six other holdings registering a share price total return of more than 28 per cent. Three names enjoyed modest gains while just one holding, GCP Infrastructure Investments (GCP), was down. All but two trusts delivered yields of more than 4 per cent, although it should be noted that Fair Oaks Income’s contribution skews the portfolio average somewhat. If that trust is removed from the results, the portfolio yield comes to a lower but still very attractive 5.2 per cent.

Simon Moore’s portfolio changes

Last year the portfolio took on more of an international flavour, with Moore wanting to limit his exposure to the UK. This meant having greater exposure to overseas equities than to the domestic stock market, but also backing trusts in areas such as infrastructure and fixed income that went further afield for returns.

“Last year there was lots of uncertainty with the pandemic and Brexit, so I wanted to limit the amount I had in UK equities and maximise exposure to other equities or asset-backed investments,” he says. “I had more weight in things I had more confidence in. That paid off: there were some really good performers. There were also some that didn’t work out, but that’s why you have a portfolio approach.”

Moore now feels some of the uncertainty has abated, giving him the freedom to focus more closely on domestic assets and rely less on last year’s biggest positions. This explains his decision to cut the positions in LXI Reit (LXI) and BBGI Global Infrastructure (BBGI) from 15 to 10 per cent each. However, he continues to back LXI for its proactive approach and ability to “prove” its NAV calculations by selling assets, while still liking BBGI for its inflation-linked assets and global approach.

Some smaller positions have exited the portfolio for different reasons. Moore is selling Henderson Diversified Income Trust (HDIV), a name he favoured for its flexibility last year, because of concerns about rising interest rates and their negative effect on bond prices. He also drops JPMorgan Global Emerging Markets Income Trust (JEMI), having grown uneasy about the level of overlap between this trust and another holding, Henderson Far East Income (HFEL). Finally, Moore is selling Tritax EuroBox (EBOX). While it has done well both in terms of income and total return, Moore now worries about valuations on the trust’s shares itself and the prices the fund has had to pay for some acquisitions. As he puts it: “I’ve have a good run and I’m banking my profits”.

Three new names enter the portfolio, all from the alternatives space. Moore adds Princess Private Equity (PEY). Like many of its peers the trust’s shares have traded on a wide discount despite strong performance, although this fund also pays dividends from capital. Moore also adds Home Reit (HOME), which focuses on accommodation for the homeless, and renewable infrastructure name NextEnergy Solar (NESF).

He also increases the size of an existing position in Aberdeen Standard Equity Income Trust (ASEI) from 5 to 10 per cent of the portfolio, having become less worried about prospects for the UK market. It should be noted that Moore sits on the board of both Home Reit and another holding, Athelney Trust (ATY).