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 [1] were about as fashionable as flared denim.
But apparently even flares are due for a revival [2] – 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 [3] explicitly change its mandate to target higher dividends in the future. (RIT is a Rothchild family wealth vehicle [4], 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 [5] has shown up is in equity income [6]investment trusts.
During the crisis I was able to flag up [7] such trusts trading at double-digit discounts [8].
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 [9]
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 [10] whether they’ll ever get the chance to buy UK equity income on a discount again.
For a while it seemed unlikely [11]. But nothing lasts forever [12] 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 [13] (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
[14]
Merchants – 5.0% yield / 5% discount
[15]
Temple Bar – 3.3% yield / 5.9% discount
[16]
Standard Life Equity Income – 3.5% yield / 8.9% discount
[17]
Invesco Income Growth – 3.5% yield / 7.5% discount
[18]
Lowland – 2.8% yield / 8.2% discount
[19]
Perpetual Income & Growth – 3.0% yield / 4.4% discount
[20]
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
[21]
Finsbury Growth & Income – 2.0% yield / 0.3% premium
[22]
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 [23] 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. [↩ [28]]