Five trust tips for growth and income investors in 2014
As mentioned in our introduction, Money Observer's niche opportunity investment trust and closed ended fund selections had a rewarding 2013, especially those that are structured to do well when markets are rising.
Those rising markets should allow highly geared ordinary shares to flourish and the ordinary shares of Aberforth Geared Income Trust duly delivered, helping the holding keep its place in this year's tips.
Worldwide Healthcare Trust have shown how rewarding warrants and subscription shares can be when the underlying trust is doing well. They have gained 192 per cent in the 12 months to 1 December 2013, compared to a 52.7 per cent total return on the ordinary shares of WWH. However, due to their final excercise date being halfway through 2014, they have been replaced this year.
This year's selections are split between income and growth holdings, which are detailed below, and alternative and balanced investments.
Venture capital trusts
Northern 2 VCT
VCT shares are gaining popularity as a source of attractive tax-free income, with the potential for some long-term growth. The best returns can be achieved by buying newly issued shares in a well-established VCT, as this secures up to 30 per cent tax relief plus immediate participation in distributions from a maturing portfolio. This is a sensible choice for investors prepared to hold for at least five years.
Although buying shares in the secondary market brings no upfront tax relief, there is more choice, there is no need to hold for at least five years, and - as with newly issued shares - distributions are tax-free, as are gains on the VCT shares themselves. In addition, some VCT shares trade at a useful discount in the secondary market, which enhances their yield.
The shares of Northern 2 VCT were last year's choice. Despite some of the best five-year net asset value returns in the sector, they offered a tax-free yield of 8 per cent and traded on a 19 per cent discount.
The discount has halved and may not fall much further, but it should not widen much either, as the trust buys back shares to maintain a single-figure discount. Portfolio gains must now make the running, and the portents look positive as the VCT's sizeable exposure to industrials/manufacturing and business services should benefit from a strengthening UK economy. The tax-free yield is down to 7.4 per cent, but is backed by useful revenue reserves, and looks very secure. For a 40 per cent taxpayer it is equivalent to a gross, but taxable, yield of 12.33 per cent.
Highly geared ordinary shares
Aberforth Geared Income Trust Ordinary Shares
Each year we warn that income and residual capital shares of split capital trusts should only be bought by investors who are bullish about the investment outlook. Inherent gearing means both net asset value per share and income can be hard hit by any setbacks. On the other hand, most offer decent yields and their total returns can be very good when things go well.
The ordinary shares of Aberforth Geared Income Trust have performed splendidly over the past year, and the trust is not due to wind up until June 2017. Net gearing of around 41 per cent should continue to accelerate any gains. The gearing is achieved solely though its zero dividend preference shares, full repayment of which is covered more than twice by the current value of its assets. The ordinary shares get all the income from the portfolio, giving them a yield of 4.1 per cent.
Just as importantly, the value-oriented investment approach of Aberforth Partners seems to be working well, after several years when a growth style dominated. The portfolio is invested in a well-diversified range of UK smaller companies with sound balance sheets and robust outlooks which are trading on below-average price/earnings ratios and offer above-average yields.
Zero dividend preference shares
Utilico Investments 2016 ZDPS
Zeros were once touted as the investment that lets you sleep well at night. This proved nightmarishly untrue for some over-geared split capital trusts, but should not be too misleading as regards well-covered zeros with sensibly invested portfolios.
The appeal of such zeros is that their shares should rise relatively steadily towards a fixed redemption price at a fixed date, and the return is all capital gain, so potentially tax-free.
In making our choice we looked for a well-covered zero with a competitive redemption yield, and have avoided those with more than a couple of years to run, as their prices could be vulnerable if interest rates rise. The 2016 zeros of Utilico were last year's choice. They have gained 7 per cent, which has reduced their redemption yield to 4.3 per cent; however, anything with a higher redemption yield looks more vulnerable to a market setback. We have therefore retained them as our selection.
JPMorgan Overseas Trust Subscription Shares
Although the warrants of Worldwide Healthcare Trust still look reasonably valued, their final exercise date is 31 July 2014, so we are replacing them with the subscription shares of JPMorgan Overseas Trust, which can be exercised in October 2014 and 2015. With the warrants priced at 53p, the price of the ordinary shares needs to grow by 5.5 per cent a year for them to break even by October 2015. Any growth above that and the warrants should do well.
JPMorgan Overseas has performed creditably in the five years since Jeroen Huysinga took charge. He and his 57-strong team of specialist analysts search for companies with attractive valuations and growth potential where an identifiable catalyst gives a compelling timeline for investment. At this juncture the majority of the trust's 70-plus holdings are quoted in the US, Europe or the UK, with less than 15 per cent invested east of Suez. Its 9 per cent gearing is average for the global growth sector.
Private Equity Trusts
Fund of funds: Graphite Enterprise Trust
Discounts to NAV have tumbled across the private equity sector, which means it is more difficult to find exceptional value. However trusts with relatively mature portfolios should be able to make further rewarding realisations while markets remain strong.
Graphite Enterprise Trust has done well in its first year as our private equity fund of funds. Helped by a series of sales at substantial premiums to carrying values, its NAV total returns have been the best in its sector over the past 12 months, and a contraction in the discount has further enhanced share price returns.
It holds its place because it remains close to 90 per cent invested, and around half its portfolio has been held for three years or more. The UK accounts for around 47 per cent assets, and is largely accessed through funds managed by Graphite Capital, which has a strong track record. Most of the rest is in Europe, and is accessed through carefully selected funds managed by third parties.