- Investment trusts have endured, largely unchanged, since the late 1800s
- The closed-ended structure, and not having to manage inflows and outflows, has been found to contribute to performance
- Flexibility of income generation will be important in a changing monetary policy environment
There are relatively few things that can claim to have been relevant for over 150 years. Trains and flushing toilets perhaps, but few will regret the passing of typewriters, cassettes or the Sony Walkman. In contrast, investment trusts have endured, largely unchanged, since the late 1800s so, to our mind, must be doing something right.
A recent survey by CASS business school showed that, all other things being equal, investment trusts tend to outperform their open-ended collective fund equivalent. This was not, as might be suspected, because investment trusts tend to employ leverage in rising markets, or have greater weighting in small caps, though these factors also contribute to performance. The real difference was that the closed-ended structure, and not having to manage inflows and outflows.
We certainly see this as an advantage on Shires Income PLC. We have an income mandate and often the best places to find higher income are among less liquid asset classes. While low interest rates have seen investors crowd into many income-generating assets, less liquid options have been left behind. This means they generally retain a more attractive income.
We see this in areas such as preference shares, or convertibles. Preference shares take precedence over ordinary shares for payment of dividends and return of capital if a company goes into insolvency. They tend to pay a higher income than ordinary shares and the dividend is fixed, rather than being set by the company’s management team every year.
Convertibles are bonds that can be converted into shares at certain times during their life, usually at the discretion of the bondholder. They tend to be shorter-term – and therefore less sensitive to rising rates – and are ranked highly in the event of insolvency. The drawback for some investors is that they are illiquid with a relatively small market. However, the closed-ended structure of investment trusts means that we can manage this illiquidity to boost the income for our investors.
The investment trust structure offers us other options to boost the yield. For example, we can boost the yield with the use of leverage. This is where we borrow money to invest in assets in the hope that the investment return exceeds the cost of borrowing. It can be risky to do with a stock market portfolio because the capital value can bounce around, and there may be a mismatch between the borrowing and the dividends generated by the stock portfolio. We ensure that borrowing is only set against the fixed income part of the portfolio, where we can be reasonably sure that the income will exceed the cost.
Selling options on our portfolio of shares is another way tool to boost the income. These options give the buyer the right (but not the obligation) to buy the shares at a certain price (the ‘strike’ price) at a certain time. For this, we receive a small payment that we add to the income we distribute to shareholders in the trust. This can cap the upside for the shares, but it suits our mandate of delivering a stable income and long-term capital growth.
Day to day, the closed ended structure means that Shires Income can invest where we want to invest, rather than having our investment selection influenced by the need to manage inflows and outflows. Although the majority of Shires Income’s holdings are in larger capitalisation stocks, we like to retain the firepower to invest in smaller companies to boost long-term growth. As it stands, we have around 15% of the portfolio in smaller companies. While a high yield is important, it is also important that the income grows over time and here, smaller companies can help.
We believe this creative approach to income generation will be particularly important at a time when the monetary policy environment is changing. Although we believe interest rate rises in the UK will be, at most, moderate, the direction of travel may shift and we need to be prepared.
The biggest problem may be that the market changes its view of income. For some time, alternative income sources have been prized because there was little income available from bonds. There is a danger that this changes as bond yields rise. We believe generating income from a range of different areas and retaining flexibility in the portfolio will protect our investors from some of that volatility.
The investment trust structure is important in allowing us to do this. Having captive assets, and not being forced to manage inflows or redemptions gives us the freedom to invest in a broader range of assets. At the same time, the ability to use leverage and derivative instruments are useful tools in boosting the income over the long-term. As the market shifts, we believe flexibility will be our friend.
Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
Find out more at: www.shiresincome.co.uk