Investment Trusts 30 Apr 2020
Times are tough for income investors and 2020 is looking to be a difficult year. This due to the pandemic-induced global stock market falls, resulting in many UK Companies suspending dividends. This is not good news if you are retired or planning to retire and to secure an income from investments for the years ahead.
However, all is not lost and for those seeking income many of the Investment trusts available should be considered. Investment trusts can maintain dividends during difficult and uncertain periods. So far in 2020 seven trusts have announced a further year of increased dividends.
What is an investment trust and how are they able to maintain and increase dividends you might ask? Let me explain…..
Investment trusts are public companies that seek to make money for investors by buying and selling shares in other companies or assets like sovereign or corporate bonds and other fixed income. They offer diversification and can gain exposure to a broad range of companies, regions and industries that investors may not be able to access as an individual.
Unlike unit trusts and open-ended investment companies (OEICs), investment trusts are closed-ended. They issue a fixed number of shares which can then be bought and sold on the London Stock Exchange, meaning that investors can buy and sell the shares, whenever they want.
The value of the assets held by an investment trust is known as the net asset value (NAV). Shares in an investment trust may trade for less than the NAV (at a discount) or for more than the NAV (at a premium).
The level of premium or discount changes based on changing market sentiment towards a sector and individual investment trust. If an Investment trust is trading at a discount to its NAV and the discount reduces or moves to a premium, investors will make an additional return over and above any return from the trust’s underlying assets. However, if the premium on an Investment trust reduces or a discount widens, this will detract from returns.
Investment trusts can also borrow money to invest, known as gearing. This approach can magnify gains for investors. One leading advantage, and in contrast to open-ended funds, investment trusts can keep up to 15% of their dividend income in reserve each year rather than paying it all out immediately. They can then use this reserve to supplement income payments in future years.
So, let us presume that we are not seeing a prolonged global recession and that most high yielding trusts with revenue reserves of one year or more should be able to at least maintain their dividends at the current level during 2020. Currently with the majority of investment trusts being rich in reserves and positioned well to weather the storm, we can expect the boards to pay dividends out of capital if they run out of revenue reserves, so Investments trusts are in a good position.
Take the added fact that in difficult or volatile markets, Investment trusts’ Discounts to NAV tend to widen, which can be an opportunity to buy into an Investment trust at an attractive price. Indeed, shares in the average Investment trust currently trade at a discount to the value of its underlying assets of 9.3%, which compares to 3.8% at the beginning of the year.
Stephen Lovelock Chartered Investment Manager