The broker Stifel has recently issued a report looking at the highest yielding equity investment trusts, in which they identified 32 funds with an annual income of four percent or more. Many are currently trading at double digit discounts and could experience a positive rerating once interest rates start to come down.
Whenever looking at data like this it is tempting to just focus on the headline yield, but it is always important to do your detailed research. The key things to look for include: how the trust has performed relative to its peers, the level of risk and the sustainability of the dividend.
A case in point is the highest yielder, Henderson Far East Income (LON: HFEL) that is currently paying 10.7%. Unfortunately the income has come at the expense of poor capital growth and this has prompted a rethink about its strategy.
Lead manager Mike Kerley is retiring and the Board has decided to take more of a balanced approach, although there will still be a strong focus on income. It has said that it will use the extensive revenue reserves to support the dividend during the transition period, but it remains to be seen what will happen after that.
Dividend Heroes
If you want to narrow it down you could just stick to the ‘dividend heroes’ on the list. These are the trusts identified by the Association of Investment Companies (AIC) that have successfully increased their dividends for 20 or more years in a row.
Examples in the UK Equity Income sector include: City of London (LON: CTY) that is yielding 4.9%, abrdn Equity Income (LON: AEI) 6.1%, Merchants (LON: MRCH) 5.1% and JPMorgan Claverhouse (LON: JCH) 4.9%.
There are plenty of dividend heroes operating in other sectors, but few if any of them are yielding over four percent. However, some of the ‘next generation’ heroes that have increased their dividends for more than 10 years in a row do have some nice starting yields.
One such is Murray International (LON: MYI) that is paying 4.6%, otherwise there is North American Income (LON: NAIT) four percent and Henderson High Income (LON: HHI) 6.6%. These are the exceptions though, as most of the high yielders have not established such a long and consistent record.
Revenue Reserves
One of the key safeguards to check is the level of revenue reserves. These can be drawn on to maintain or increase the distributions at times when there are dividend cuts at the companies in the portfolio.
Many of the dividend heroes made use of this facility during the pandemic and were able to protect their longstanding record of increasing their pay-outs. Open-ended funds do not have the same flexibility, which is an important consideration if you are looking for a reliable income.
Unfortunately it is not usually all that straightforward to check the level of revenue reserves. You normally have to find the latest set of accounts and look the number up on the balance sheet, before comparing it to the total dividend to see whether it is a meaningful figure.
Some trusts like the City of London make the process a bit easier and quote the revenue reserve per share. For example, in the final accounts for the year ended 30 June 2023, the figure was 8.9p, while the dividend was 20.1p, making the reserves equivalent to just under six months of distributions.
Red Flags
There are also some red flags to watch out for, one of which is if a trust is paying out a ‘fixed percentage of NAV’. The broker Stifel says that some of these – and there are nine of them on the list – may be manufacturing yield through this process.
They give the example of Montanaro UK Smaller companies (LON: MTU), which has a historical yield of 4.3%. In the 2023 financial year the revenue EPS was 2.3p and the capital return was -21p, yet the trust paid a dividend of 4.5p. This meant that it was only half covered by earnings with the rest coming out of capital.
Even where they are not doing this, it is likely that if the NAV falls in a particular year then the dividend for the subsequent period would be lower. There have been several cases where this has happened in the last year or two.
The high yielding trusts that pay a fixed percentage of NAV include: European Assets (LON: EAT), BlackRock Latin America (LON: BRLA), International Biotechnology (LON: IBT) and Invesco Asia (LON: IAT).