Five years of success: our £10,000 income portfolio has delivered once again, but to maintain the winning streak in 2020, changes have been made. Helen Pridham explains.
With interest rates at rock bottom, it is not surprising that many investors have seen buy-to-let property as one of the best ways to generate income. However, a tax squeeze in 2017 has dented landlords’ profits and hit the sector.
What’s more, property can be a very concentrated and illiquid investment. By contrast, investing for income in investment trusts offers investors a diversified, liquid, tax-efficient and relatively low-cost alternative. Such trusts are not risk-free, but they offer long-term investors great potential for inflation-beating income alongside capital growth.
A wide variety of trusts target increasing income as their primary investment objective. This is not just an aspiration. The investment trust industry boasts 20 companies that have raised their dividends for more than 20 consecutive years, plus another 22 companies that have increased their payouts for between 10 and 20 years.
Moreover, trusts have sought to meet the needs of income investors by increasing the frequency of their dividend payments. Data from the Association of Investment Companies (AIC) shows that 54% of its income-paying member investment companies (excluding venture capital trusts) now pay quarterly dividends. Yields are attractive. In 2019, the AIC noted that 15 investment company sectors were paying average yields of more than 3%.
To help income investors put together their own portfolio of trusts, the AIC launched its online income-finder tool in 2019. This enables an investor to create a virtual portfolio of income-paying investment companies. It shows dividend dates and how much income these companies would generate over a year.
Money Observer was ahead of the game in recognising the income-focused benefits of investment trusts. Five years ago we decided to demonstrate how an investor could put together a portfolio of trusts to achieve a target income of £10,000 a year. The portfolio has been reviewed and reworked every year since, and switches made where necessary for new investors.
At the same time, we have consistently warned that there is no guarantee that the portfolio will achieve its objectives. There are risks with any form of stock market investment, especially over the short term – the portfolio should only be considered if you are prepared to invest for the medium to long term.
As it happens, since the start of this exercise in 2015, the portfolio has delivered more than the targeted £10,000 of income each year, although its capital value has fluctuated. In three of the five years, it has risen and in two it has fallen, but the increases have, so far, offset the falls. In 2019, the portfolio produced 1.8% more income than predicted and rose by 12.5% in capital terms.
While share price increases are good for existing investors, they push yields down. This means new investors need to stump up more capital to achieve the same starting income. For 2020, the amount required for our portfolio has risen to £245,000 (compared with £224,500 a year ago). Less capital would be required if more investments were placed in the highest-yielding trusts, but we believe a more balanced portfolio produces better long-term results.
Portfolio performance in 2019
Jan 2019 £
Jan 2020 £
paid in 2019 £
|UK EQUITY INCOME|
|City of London||25,000||28,799||1,221|
|Troy Income & Growth||25,000||29,424||943|
|JPMorgan Global Growth & Income||25,000||30,342||1,108|
|Seneca Global Income & Growth||25,000||28,008||1,044|
|BMO Commercial Property||15,000||13,917||722|
|Schroder Oriental Income||17,500||19,461||762|
|Standard Life Private Equity||10,000||10,773||396|
Sources: AIC/Morningstar data, as at 2 January 2020, and Money Observer calculations.
Solid domestic footing
Four of our holdings are UK equity income trusts. These account for just over 40% of the portfolio. It is important for investors to keep a good portion of their portfolio in their home market to avoid taking on too much currency risk.
Each holding has a somewhat different approach. City of London is one of the largest investment trusts investing in the UK market. It focuses mainly on large, blue-chip UK equities and is very diversified, with about 100 holdings. This year will be the 54th year in which it has increased its dividend – the longest run of any investment trust.
Merchants, a new addition to our UK segment, invests across the company size spectrum and has a more concentrated portfolio. It has achieved year-on-year dividend growth for the past 37 years. Merchants has been brought in to replace Troy Income and Growth, which has a cautious and conservative approach. We believe Merchants may be able to take greater advantage of a recovery in the UK market that we think could occur in 2020.
Diverse Income, which has a heavy weighting towards smaller UK companies, paid out more income than we had predicted in 2019. But on the capital front, it had a difficult year, not helped by Brexit uncertainty and negative sentiment towards smaller companies. Fortunately, following the recent general election, its price recovered, and we believe it could do well in 2020 as more investment flows back into UK equities. A cut in its management fee announced last year adds to its appeal.
Shires Income had a good year under its new manager. In capital terms, it was our best-performing holding in 2019. It invests in a mix of equities and fixed-income securities, mainly preference shares, which account for around a quarter of its portfolio and enable it to pay out an above-average yield. Its share portfolio is invested in companies of different sizes and is well-diversified, which should stand it in good stead in 2020.
UK trusts tend to provide higher yields than their global equivalents, but we believe it is important to have plenty of global exposure in order to spread risk. This year we have increased the number of global holdings from three to four. They are all slightly different.
Murray International has the highest yield in the global equity income sector, but what really differentiates it is the trust’s high weighting to Asia and emerging markets as well as its 15% exposure to bonds. Its emerging market exposure has hampered its capital performance in recent years, but we think 2020 could be a better year for the trust.
Seneca Global Income and Growth adopts a mixed-asset approach and appears in the ‘flexible’ sector. Its portfolio is a mix of UK and overseas equities, fixed interest and other asset classes, including property and alternatives. It invests via funds to gain its overseas, fixed-interest and alternatives exposure. Its chief investment officer, Peter Elston, departed at the end of 2019, but we believe the trust’s team-based approach will keep it on track.
JPMorgan Global Growth and Income was our second-best performer in 2019. It also underwent a change of manager early in the year, but its investment process has remained the same. Its quarterly dividends of at least 4% of net asset value are set at the beginning of each financial year.
Our new holding in this category is Securities Trust of Scotland, which has an investment mandate that is not constrained by index considerations, so its manager can invest wherever he sees the best prospects. It replaces European Assets, held last year, as we believe the new trust’s broader investment spread will better underpin our portfolio’s aim to provide rising income and capital growth.
How the portfolio for 2020 shapes up
|UK EQUITY INCOME|
|City of London||3.1||4.3||35,000||1,505||0.77||Jan, Apr, Jul, Oct|
|Diverse Income||-3.6||3.8||25,000||950||1.27||Feb, May, Aug, Nov|
|Merchants||2.2||4.8||25,000||1,200||0.96||Mar, June, Sep, Dec|
|Shires Income||1.2||4.5||25,000||1,125||1.68||Jan, Apr, Jul, Oct|
|JPMorgan Global Growth & Income||3.8||3.8||25,000||950||n/a||Jan, Apr, Jul, Oct|
|Murray International||6.1||4.2||25,000||1,050||1.07||Jan, Apr, Jul, Oct|
|Securities Trust of Scotland||2.1||3||15,000||450||0.32||Jan, Apr, Jul, Oct|
|Seneca Global Income & Growth||0.3||3.7||25,000||925||0.6||Feb, May, Aug, Nov|
|BMO Commercial Property||-12.5||5.2||15,000||750||2.25||Monthly|
|Schroder Oriental Income||1.4||3.9||15,000||585||1.15||Mar, June, Sep, Dec|
|Standard Life Private Equity||-20.5||3.7||15,000||555||n/a||Mar, June, Sep, Dec|
Note: *The number of years current reserves can cover the last full financial year of dividends. Sources: AIC/Morningstar data, as at 2 January 2020, and Money Observer calculations.
Completing our income portfolio are three specialist trusts that provide additional overseas and asset diversification. There is one less holding in this category than there was last year, as we have decided to switch out of European Assets, as previously mentioned.
The remaining three holdings are the same as last year. Schroder Oriental Income extended its good track record in 2019: it paid out a higher dividend for the 13th consecutive year. The trust is spread across 14 countries, with Hong Kong, Australia, Taiwan and Singapore forming the core. It is managed by the highly experienced Matthew Dobbs, who takes a bottom-up stockpicking approach that focuses on high-quality companies with strong balance sheets.
Standard Life Private Equity, which was added to the portfolio a year ago, provides exposure to fast-growing private companies that would not otherwise be accessible to private investors.
It does so through a combination of direct investment and private equity funds, so there is a wide spread of risk. Its portfolio is broadly diversified by country, industry sector, maturity and number of underlying investments, although in terms of geographic exposure, it is mainly focused on Europe. Its quarterly dividends are partly paid out of capital.
The only portfolio holding that lost capital value during 2019 was BMO Commercial Property, previously F&C Commercial Property. In 2018, the trust was our best performer in capital terms, having proved to be the most resilient of our holdings. However, Brexit uncertainty and problems in the retail sector have had a negative affect on the UK commercial property sector. Nevertheless, we believe the monthly income paid by the trust is attractive and that over the longer term the property market will recover.
Portfolio repositioned to make the most of dividend growth
OUT: Troy Income & Growth
The managers of Troy Income & Growth are known for their cautious approach: the trust focuses on high-quality companies that have recurring revenue, predictable growth and high free cash flow. The managers’ emphasis is on capital preservation and delivering real income growth in excess of inflation. The trust has achieved good, consistent returns since the current managers took over. However, in the expectation that the UK market may perform better in 2020 now that there is greater certainty about Brexit, we have decided to switch to a more adventurous trust. For existing investors who are happy with Troy Income & Growth’s low-risk approach, there is no reason to switch.
Merchants’ objectives are to provide above-average income, income growth and long-term capital growth through a policy of investing mainly in higher-yielding, large UK companies. It has a higher yield than Troy Income & Growth and is one of the AIC’s dividend heroes. It has achieved year-on-year dividend growth for the past 37 years. Simon Gergel, manager of the trust for the past 14 years, runs a relatively concentrated portfolio of 40-60 holdings. Despite the UK’s difficulties since the Brexit referendum, he says he continues to find many opportunities to buy sound businesses trading on attractive valuations and offering above-average dividend yields.
OUT: European Assets
This trust has provided the portfolio with useful exposure to European smaller and medium-sized companies, and its high yield has boosted the portfolio’s income. However, its quarterly dividend is based on 6% a year of the year-end net asset value (NAV), so it is vulnerable to declines in the NAV, which contributed to the lower-than-expected income it produced last year. We still have a lot of faith in its manager, Sam Cosh, but with uncertainty building about global growth this year, we have decided to increase portfolio diversification by adding another global equity income trust. There is no reason for existing investors to switch if they remain happy with this trust.
IN: Securities Trust of Scotland
We have added this trust to increase the portfolio’s global exposure. It has an exposure to Europe of around 45% and a similar weighting to North America. It is managed by Mark Whitehead, who has adopted a bottom-up approach focusing on high-quality, large-cap firms with sustainable earnings and dividend growth. Environmental, social and corporate governance factors are key considerations. The trust has a relatively concentrated portfolio of 35-55 stocks.
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