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Investment trusts for deaccumulating income investors

by The Greybeard on May 18, 2015

The Greybeard is exploring post-retirement money in modern Britain.

I have mentioned before that I’m starting to re-position my SIPP towards income generation rather than capital growth.

At the age of 60 – and expecting only a very gradual transition into full retirement – it’s a plan that makes sense.

When retirement finally arrives, I’ll have a pretty good idea of the income that I can expect, because it will be the income that I’m already receiving.

I have also mentioned that my income generation route of choice is a carefully-chosen basket of investment trusts.

Why investment trusts?

Three main reasons.

First, they’re collective investments, offering diversified exposure to different geographies and markets, and different types of businesses – such as Asia, UK smaller companies, North America, and FTSE 100 stalwarts.

I could buy these shares directly, to be sure. But it seems smarter to leave it to experts who can do it at a lower average cost.

Second, the ongoing charges for investment trusts are generally a lot lower than with open-ended investment funds (“OEICs”).

As regular Monevator readers know all too well, high charges eat into not only capital growth but also income. So if I want diversified exposure and active management, investment trusts are the way to go.

And third, the closed-end nature of investment trusts means that they can (and do) throw up opportunities where the share price can be at a discount to the underlying stocks that the trust holds – or the Net Asset Value as it’s termed.

Sometimes, those discounts can be tasty, rather than a handful of percentage points. Bide your time, and maybe there will be a chance to buy a pound’s worth of income-generating assets for 80p.

To be sure, I have other reasons for preferring investment trusts – investment trusts’ income reserving regimes help them to smooth income payouts, for example – but those three are the main appeal for me.

Which investment trusts?

Choosing which trusts to go for is, alas, a much tougher call.

Long in the shadow of their open-ended brethren – thanks to such funds’ juicy pre-RDR commission payments and hefty advertising budgets – investment trusts have typically received far less media attention, with few outlets providing regular coverage.

Data coverage has been fairly patchy, too.

Post-RDR, for instance, fund supermarket Hargreaves Lansdown has bolstered the coverage that it provides in respect of investment trusts. But before that retail investors had to chiefly rely on sources such as FE Trustnet, Morningstar and industry organisation the Association of Investment Companies (AIC) – and especially its aicstats website – for decent data. All are unfamiliar venues for the typical retail investor.

Moreover – and this is a purely personal perspective – the data that these various outlets have provided hasn’t been to everyone’s taste.

Or, more precisely perhaps, my taste.

Citywire, for instance, often bangs on about those discounts and premiums to Net Asset Value. Yes, discounts and premiums are worth bearing in mind. But for me, it’s investment trusts’ charges that are more important, particularly in a trust that is to be held for the long term.

So, as I’ve said before, I set out to build my own set of comparative data, capturing the facts and figures on which I wanted to focus, and recording them on a spreadsheet.

The team at Monevator (who are more technically minded than I am) urged me to do this using an online spreadsheet, which (apparently) will help us to keep it up-to-date.

They’ve even set up a dedicated page on Monevator for my investment trust table. You can follow that link to see it, or click on the image below.

Click to see the full investment trusts for retirees table

So what does my table tell us?

Various things, I think.

Creating it has certainly been a most instructive (if long-winded) exercise.

First, the prospective yield on offer varies widely, even ignoring battered resource-centric trusts such as BlackRock Commodities Income (which I hold), and BlackRock World Mining. These offer high yields of 6.7% and 6.5% respectively at the present time – but the latter isn’t (strictly speaking) an income trust at all.

Proper income stalwarts, such as the venerable City of London (which I hold) and Murray Income offer something much closer to the Footsie’s average yield – respectively 3.7% and 4.1%.

Second – and even among traditional income stalwarts – there’s a surprising breadth of charges. I don’t mind paying something in the range of 0.40-0.50%, but much above 0.55% starts to look a little steep for a fund with a ‘long term buy and hold’ ethos.

In particular, Baillie Gifford’s 0.9% for Scottish American seems a little steep, as does Diverse Income Trust’s 1.33% and Perpetual Income and Growth’s 0.93%. (Disclosure: I hold Scottish American, but outside my SIPP.)

Third, some of the trusts are really a play on dividend growth, rather than income. When looking at a trust offering a yield of 2.3% (Bankers) or 2.9% (Perpetual Income and Growth), you must remember that you get around a third more income from a Footsie tracker, and at a lower cost. The managers must deliver superior income growth in order to justify their share prices.

Four, most of these income-centric trusts offer quarterly dividends. It doesn’t make any difference to the absolute level of income paid, but a smoother cash flow always strikes me as a better cash flow. So venerable trusts such as Law Debenture look to be hold-outs by sticking to a policy of twice-yearly payouts.

And finally, five, some trusts do seem to trade at fairly hefty average premiums. If these trusts take your fancy for other reasons, then it could well be worth keeping an eye on the actual day-to-day premiums, looking for windows of opportunity. Law Debenture is again an interesting example.

What next?

As I’ve said, I found the exercise instructive, and the job isn’t done yet. So the next time you see this table, it will hopefully look a little different.

Income reserves, for instance, might make a useful additional column, and I’ll look to add that.

Moreover, when you take a look at trust’s individual major holdings, it’s clear that there are some significant differences of managerial opinion, with trusts with purportedly very similar income generation remits holding very different baskets of shares. This is more difficult to encapsulate in a brief comment or statistic, but potentially very useful.

And useful though the Morningstar ratings are, they’re not necessarily giving the same weight to income dependency as I would. Going forward, I hope to add something there.

Finally, I’m open to suggestions about other trusts I might add to this table.

I’ve found the whole exercise very useful, and have two new ‘buys’ firmly earmarked. (Law Debenture and Dunedin Income Growth, since you ask.)

See all The Greybeard’s previous articles.

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Weekend reading: Passive investors should bring Larry Swedroe to a knife fight

by The Investor on May 16, 2015

Good reads from around the Web.

Perhaps it’s because it was the first film I saw at the cinema with my own money – and without my parents – but I often recall the life lessons taught by Crocodile Dundee, not least when I first encountered a bidet in Paris 20-odd years ago.

Alas, when I was mugged (with an axe!) in the late 1990s I was insufficiently armed to create this famous moment from the movie:

I thought again of this scene when I read Larry Swedroe demolishing an argument in favour of active investing over at ETF.com.

After gently cutting the argument to shreds, Swedroe concludes:

The bottom line is that there’s no real cyclicality in the percentage of active managers who outperform, at least not when you measure things properly.

And there’s nothing presented in the article that should convince you that using actively managed funds is the winning strategy at any time.

Sorry, active fund management industry.

To mix my movie memes…

[continue reading…]

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Weekend reading: Another reminder that most active managers fail

by The Investor on May 9, 2015

Good reads from around the Web.

While naughty active investors like me can always find something to excite us (cheap income trusts, anyone?), the passive investing slog can be a repetitive one.

Excellent passive investing basically involves setting up your ‘machine’ and then fueling it with cash. If you’re monitoring it and tweaking it too much, you’re doing it wrong.

That makes blogging about passive investing difficult – many of our brightest and best pupils leave us on graduation. Not good for growing a readership!

But it also presents a challenge for passive investors, who might eventually forget why they choose this road.

That’s one reason why we happily bang out the same old tunes every few weeks about cheap funds and trying not to be be too clever.

It might be repetitive to read, but then so is jogging and eating porridge for breakfast and a host of other things that are good for you.

Vitamin data

Another good pick-me-up is a burst of powerful data.

As passive specialist Rick Ferri said recently:

The long-term data comparing active funds to index funds shows actively managed mutual funds underperform in all asset classes and all investment styles. There is no ambiguity in the results, and there’s nothing new to report here. The data has been saying the same thing for decades.
But, we’re only human.

We forget, and lies are constantly being told that cause us to second-guess our resolve.

It’s a good idea to revisit the data at least once a year just to remind ourselves why we believe what we believe: that we should continue to invest in index funds rather than active management.

Ferri cites two new studies that demonstrate the superiority of passive investor for most people. All good stuff.

However it’s often said that a graph is worth 1,000-words of promotional guff from the active fund management industry, and Ferri shares a beauty:

Percentage of active managers underperforming over 5 years ending 2014

Percentage of active managers underperforming over five years to 2014

Source: Rick Ferri

The data shows clearly that most managers fail to beat the market over a five-year period.

[continue reading…]

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UK equity income trusts trading at a discount (blame the politicians?)

by The Investor on May 7, 2015

Many UK equity income trusts are now trading at a discount again (illustrated here by a London Underground ‘mind the gap’ image)

A big theme in the post-crisis years has been the hunt for a higher income yield – including the yield you get from dividend paying shares.

This love of dividends has been quite a turnaround from the decades prior to 2007 and 2008.

For most of my life, dividends were about as fashionable as flared denim.

But apparently even flares are due for a revival – and dividend investing long ago recaptured the heart of the mass investor.

The most obvious cause is six years of interest rates at record lows. We’ve even seen negative yields on some European long bonds.

Near-zero interest rates sent would-be cash savers into bonds, and in turn the more adventurous would-have-been bond investors into so-called ‘bond proxies’ – dividend-paying shares in relatively stable and defensive companies (or ‘quality’ stocks as we now seem to call them) such as food producers and utilities.

I also think the accounting chicanery and financial engineering of the last boom caused people to reconsider the virtues of real cash paid by real companies.

Whatever the reason, we’re all John D. Rockefeller now.

The legendarily wealthy tycoon once quipped:

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

From discounted goods to premium produce

Of course, investing for dividends never actually went away.

Neil Woodford – probably the most popular UK fund manager of his generation – built his career buying unpopular stocks for income. In his pomp at Invesco Perpetual, Woodford was running nearly £25 billion in income orientated money.

But in recent times more and more generalist fund managers also began praising the virtues of dividends.

We’ve even seen venerable trusts like RIT Capital Partners explicitly change its mandate to target higher dividends in the future. (RIT is a Rothchild family wealth vehicle, and those guys didn’t get to where they got without having a nose for fashion in finance.)

Another place where the popularity of income investing has shown up is in equity income investment trusts.

During the crisis I was able to flag up such trusts trading at double-digit discounts.

A discount indicates that you are paying less than the underlying holdings of the trust are worth – a bit like buying £1 coins for 90p.

Such “really?” sized discounts are not unusual with, say, private equity trusts – where people may have doubts about the true value of the trust’s holdings – or with trusts where a major shareholder is potentially distorting the playing field.

But for veteran UK equity income trusts holding bog standard blue chips, it was pretty unusual.

Most such trusts have a very good record, are well-managed, and you’d expect the dividend payout to provide some valuation support in comparison to a non-dividend paying trust, because with an income trust, the wider discount, the greater the effective yield you get paid from the underlying assets on your initial purchase.1

Sure enough, the big discounts didn’t last long. The trusts were soon trading at a premium, as that hunt for yield I talked about kicked in.

Indeed over the past few years I’ve heard investors wondering whether they’ll ever get the chance to buy UK equity income on a discount again.

For a while it seemed unlikely. But nothing lasts forever in investing.

The premiums have actually been coming down for the past year or so until… here we are, with the majority of UK income trusts on a discount again.

Income investment trusts on special offer

True, we’re not (yet?) talking double-digit discounts, but the trend from trading at a premium to a below-par discount is clear in most of the popular trusts.

Look at the graphs below that I’ve pulled from AICstats (an excellent source of data on investment trusts of all flavours).

All these graphs cover the five-year period from Spring 2010 to May 2015.

I’ve also included the dividend yield as per yesterday’s close.

Edinburgh Investment Trust – 3.5% yield / 4.1% discount

Merchants – 5.0% yield / 5% discount

Temple Bar – 3.3% yield / 5.9% discount

Standard Life Equity Income – 3.5% yield / 8.9% discount

Invesco Income Growth – 3.5% yield / 7.5% discount

Lowland – 2.8% yield / 8.2% discount

Perpetual Income & Growth – 3.0% yield / 4.4% discount

A couple of income trusts still trading on a premium… just!

Not every income trust is trading below its net asset value, but it’s close.

And even where premiums are in place they are slender, as typified by the venerable City of London trust and by cult fund manager Nick Train’s Finsbury Growth and Income trust:

City of London – 3.8% yield / 0.7% premium

Finsbury Growth & Income – 2.0% yield / 0.3% premium

Fill your boots?

The obvious question is why most income trusts have gone from sporting big premiums to discounts.

I don’t know the answer, although I can think of plenty of potential reasons:

Some of these trusts have had a recent poor run (e.g. Temple Bar, which I have bought myself for that reason, among others).

The shine has come off some – not all – bond proxies (Diageo springs to mind).

Investors have grown wary of chasing higher prices, even where the trust’s underlying assets have continued to pile on the pounds.

The post-RDR focus on costs that gave investment trusts a moment in the sun has passed.

The bonds-for-shares trade is wearing thin (everyone who might make the trade has done it?)

Supply and demand: The growing popularity of index funds and ETFs (including some ETFs that explicitly focus on income) is reducing the appetite for investment trusts.

Bond yields have bottomed, and that’s feeding through into reduced demand along ‘the curve’.

None of these explanations is wholly satisfactory to me.

For example, while I suspect the bond mania may have seen its last full-on hurrah, until very recently yields were at record lows – yet some of these trust discounts have been blowing out for a while.

On balance I think the UK election is a plausible cause.

It might not seem to make much sense, because these trusts are overwhelmingly investing in large multinationals that get most of their income from overseas.

However I’d bet a majority of purchasers of UK equity income trusts are British, and there are reports that UK investors are curbing their enthusiasm due to the election.

So is this a buying opportunity?

I must admit my crystal ball is on the blink.

It’s not inconceivable that the canny market has sniffed out the end of ‘reaching for yield’ long before market pundits and humble bloggers like me have noticed.

In that case discounts on income trusts could continue to widen. Their returns versus the market could be dampened still further by a relative sell-off in the higher yielding stocks the trusts own, too.

And of course the market could crash at any moment, like always. Old age doesn’t explicitly kill bull markets, but it does bring the day at the knackers yard ever closer.

All that said if you’ve been waiting to invest in equity income trusts on a discount simply because you don’t want to overpay on principle, your moment has arrived.

But be aware that doesn’t mean it won’t arrive some more.

I’m not saying that’s logical: You still get a higher ‘earnings yield’ from non- or low-yielding trusts. I’m saying it’s how the mind of an income investor works. [↩]

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