The IC investment trust income portfolios: our changes for the year ahead

The idea that investment trusts provide a reliable income through thick and thin has truly been tested in recent years, from the UK equity dividend suspensions of 2020 to the bond sell off seen over the last two years and the consequences that has had for yield-rich 'alternative' assets. Many trusts have indeed kept their promises on income, but not without plenty of volatility and disruption for shareholders as the sector comes under strain.

That’s evident enough from a glance at our two investment trust income portfolios. The two hypothetical £100,000 portfolios, put together by IpsoFactor Investor chief executive David Liddell and Trust Research director Simon Moore, both generated good levels of yield between the start of October 2022 and the end of September 2023.

But neither portfolio has escaped the turbulence of the broader sector: Liddell’s most prominent holding has faced questions about its future and one of Moore’s picks has upended the entire portfolio in more ways than one. In the case of Moore's portfolio, some unusual circumstances have obliged us to find a new specialist to put together a set of investment trust income picks.

A new face

The investment trust sector has experienced a huge amount of upheaval in the last year, from mergers to dramatic continuation votes and even some share suspensions. As it turns out, an example of the latter has prompted a notable change to this feature.

Moore has put together a hypothetical investment trust income portfolio for the IC for several years. In recent times he has included two trusts, Home Reit (HOME) and Athelney (ATY) in his list - with the disclaimer that he sits on the boards of both.

As many readers will know Home Reit has been hit by scandal in the last year: as IC property writer Mitchell Labiak has extensively reported, HOME's problems have included tenants going bankrupt, broader questions about the financial viability of the portfolio, a short seller attack, a strategic review and the suspension of the trust's shares. More recently the trust has appointed a new investment manager, tasked to “undertake a thorough review of the company’s assets”, as well as selling some properties and engaging with the fund’s tenants “regarding issues with their properties that may have been previously unaddressed”, while improving rent collection efficiency.

As our table shows, the trust's near-implosion, which included a loss of nearly 57 per cent for shareholders before the shares were suspended, has had a significant impact on Moore’s hypothetical portfolio. The losses could well increase if and when the shares trade again. Moore has duly stepped down from running his IC portfolio, and another specialist has stepped in to take the reins in the form of James Carthew, head of investment company research at QuotedData.

Before we get to Carthew's new picks, it's still worth seeing how Moore’s final selection fared. The Home Reit losses were a huge blow, leaving the portfolio at a loss overall. But it is not the only culprit: while it has done its job when it comes to income generation, on a total return basis the portfolio would still have dipped into the red even if the Reit's performance is excluded.

Those losses relate largely to the fact that, in contrast to Liddell’s equity-heavy approach, Moore has tended to focus on generating income from alternative assets. Just 30 per cent of the portfolio was in equity vehicles, with 30 per cent in infrastructure, 20 per cent in property, and 10 per cent apiece in private equity and debt. With rising interest rates affecting the discount rates at which alternative trusts value their assets, the portfolio has had a rough ride, with big paper losses for GCP Infrastructure Investments (GCP), BBGI Global Infrastructure (BBGI), NextEnergy Solar (NESF) and Target Healthcare Reit (THRL).

Equity income play Henderson Far East Income (HFEL) has also struggled, though it’s worth noting that AEW UK Reit (AEWU), Fair Oaks Income (FAIR) and Abrdn Equity Income (ASEI) have delivered good returns.

The portfolio has also delivered in spades when it comes to income: AIC figures suggest Home Reit threw off a chunk of income before its problems truly mounted and every other fund in the list has generated a yield of at least 4.7 per cent. Debt vehicle Fair Oaks Income has once again delivered enormous levels of yield.

James Carthew's portfolio

Carthew, like Liddell, has a big position in Murray International, arguing that the approaching retirement of manager Bruce Stout should have little effect on the strategy, that the trust trades on an attractive share price discount (9.4 per cent at the time of writing) and that its value-minded approach should fare well even if interest rates stay high.

Carthew also has some other equity exposure in the form of positions in Aberforth Split Level Income (ASIT) and International Biotechnology (IBT), with the idea that both might prove to have been unduly out of favour among investors. We recently made the case for ASIT as a high-income play with winds up next year, giving investors the chance to get out at a price close to NAV.

The research head also picks equity and bond vehicle Henderson High Income (HHI), noting that this should be a form of “less risky exposure to the cheap UK” because of its partial use of fixed income assets.

In keeping with this, he also makes good use of other assets outside the equity universe, with 30 per cent of the portfolio in different infrastructure plays, 17.5 per cent in property and 12.5 per cent in fixed income offering Invesco Bond Income Plus (BIPS).

The volatility that hurt Moore’s returns in the last year has also created plenty of buying opportunities, and the metrics on many of Carthew’s picks reflect that. Take GCP Infrastructure, which recently ceased merger talks with GCP Asset Backed Income (GABI) and traded on a discount of around 40 per cent to net asset value (NAV) and a share price dividend yield north of 10 per cent at the time of writing. “Because of how it structured its investments and the fact it takes debt-like exposures, it should be less risky than funds with equity positions,” Carthew adds.

When it comes to infrastructure Carthew also likes Gore Street Energy Storage (GSF), which recently traded on a discount of nearly 40 per cent. “It has probably the most diversified portfolio of the three battery storage funds,” he says. The fund has some diversification beyond the UK via assets in Germany and the US. Carthew also believes the portfolio discount rate could fall, boosting NAV, as more assets become operational.

The portfolio also includes property exposure via Tritax Eurobox (BOXE), where Carthew notes that tenant demand for the underlying assets seems strong even if rising rates have hit the fund hard. It recently traded on a 45 per cent discount, with a yield of nearly 9 per cent.

More “conventional” real estate exposure can be pretty cyclical, and Carthew describes his position in Abrdn Property Income (API) as “the most speculative of the lot”, with question marks lingering over the level of demand for many real estate assets. But Carthew notes that this is one of the smaller property trusts, adding: “With things like discounts you can’t rule out the possibility someone might bid for it.”

Fans of our Top 50 Funds list will note that we removed API from the 2023 selection, arguing that Schroder Real Estate (SREI) seemed to be on a firmer footing in terms of dividend cover. Some of API’s shortcomings do at least seem to be in the price, however, with the shares recently trading on a 40 per cent discount to NAV and an 8 per cent yield.

It should also be noted that, like many of its peers, API has favoured popular subsectors such as industrial assets and retail warehouses over offices and high street retail buildings, with the latter two – arguably more at risk from changing property preferences – making up a relatively small portion of the trust’s portfolio.

How David Liddell’s portfolio performed

Liddell has tended to run a fairly equity-heavy portfolio, with last year’s selection having a 52.5 per cent allocation to the asset class. Given dividend-paying equities have fared reasonably well in the last year, at a time when many alternative asset classes struggling, this preference seems to have propped up total returns. Murray International (MYI) and Murray Income (MUT), both big positions in the portfolio, made some strong total returns, with an admittedly much smaller position in CC Japan Income & Growth (CCJI) making huge gains amid a big and long awaited rally for the Japanese market.

One bond fund, M&G Credit Income (MGCI) also produced a good total return, while names such as Abrdn Asian Income (AAIF) were fairly flat for the period. With alternative assets struggling, gains made in the portfolio offset share price losses suffered by Abrdn Diversified Income & Growth (ADIG), the Renewables Infrastructure Group (TRIG) and HICL Infrastructure (HICL). Overall the portfolio made a modest positive total return.

Most importantly, the portfolio has done an impressive job on the income front: two funds generated a 3.7 per cent yield, with all other names generating at least 4 per cent. The fund generated a total yield of 5.4 per cent.

Liddell's changes

Liddell is targeting a yield of 5.5 per cent over the next year, and his changes this time round mean the portfolio’s allocation to dedicated equity vehicles rises slightly but notably to 57.5 per cent. Some shifts in the portfolio relate to concerns about sectors and investment styles, while others relate to individual trusts.

Dividends in the alternative space have come under pressure in the last year and some of the alterations acknowledge these worries. Liddell exits his position in HICL Infrastructure, suggesting that its dividend could be at risk. Its main holding Affinity Water is under regulatory pressure, and Liddell suspects it has less dividend cover than TRIG.

He feels more confident on TRIG's prospects, noting that in terms of share price activity infrastructure funds seem to be “taking all the pain for higher interest rates without getting any benefit for their inflation linkage”. However the allocation to TRIG falls from 12.5 to 10 per cent in order to permit changes elsewhere in the portfolio.

Sticking with a similar asset class, he introduces a new position in JPMorgan Global Core Real Assets (JARA), which uses JPMorgan funds to access the likes of infrastructure, transport and real estate assets. “In some ways I see this replacing HICL,” he notes. “It’s a bit more diversified and has a healthy yield of 5.4 per cent. Infrastructure is out of favour and it has some Asian property so it’s a contrarian play.”

Some adjustments to the portfolio reflect Liddell’s contrarian instincts when it comes to both yield and valuation. He ups the exposure to Abrdn Asian Income in part because it comes with an attractive dividend yield (5.5 per cent) and share price discount to NAV (14.4 per cent) and even increases exposure to Abrdn Diversified Income & Growth, the multi-asset vehicle whose board recently concluded a strategic review. The board made the case for sticking with the trust's current multi-asset investment approach and to embark on a series of "enhanced distributions" to shareholders through a combination of special dividends and a tender offer. The trust holds other funds and has heavy exposure to unlisted assets, with smaller allocations to bonds and equities.

The trust's shares have languished on a discount for some years and Liddell, like some others, remains perplexed at its fortunes. “It remains somewhat of a conundrum why the market is so against this trust,” he says. “The income has kept up and there doesn’t seem to be an indication the dividend is likely to be chopped. While capital performance is disappointing the yield is still attractive and we still hang onto it.”

Returning to the subject of yield, Murray Income leaves the portfolio to make way for its sister fund Dunedin Income Growth (DIG), a name which holds a relatively similar selection of underlying assets. This change takes place “purely on the basis of a higher yield and higher discount”.

In a slightly different turn of events, CC Japan Income & Growth has performed so strongly that Liddell sees its yield (which recently came to 2.9 per cent) as now being too low, prompting its exit from the portfolio. He also reduces his exposure to BlackRock Energy and Resources Income (BERI) on the basis that chunkier yields can be found elsewhere. It recently came with a yield just shy of 4 per cent. M&G Credit Income and TR Property (TRY) stay on the same weightings as last time.

One other fund enters the portfolio alongside JARA and DIG: Liddell has introduced JPMorgan Global Growth & Income (JGGI) on a 7.5 per cent weighting as a play on global equities.