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Nick Sketch: investment trusts with an edge in income

by Nick Sketch on Mar 12, 2014 at 00:01

Nick Sketch: investment trusts with an edge in income

Four themes have deterred income-seekers from investing in investment trusts (ITs) in recent times:

1) ITs look more than usually expensive in discount terms.

2) The most expensive ITs tend to be those with a good income yield.        

3) ITs have obvious advantages but income-seekers rarely need (say) a Brazilian small cap fund

4) Onshore ITs typically have an unhelpful tax treatment on bond income

Does this mean income-seekers can ignore investment trusts at the moment? As with almost every important investment question, you won’t go far wrong saying ‘it isn’t as simple as that’. Or, as Mark Twain put it: ‘All generalisations are false, including this one.’

First, what matters most when picking any active fund should be the management quality and the portfolio. If Findlay Park American , say, were an IT, it probably wouldn’t change its attractiveness much. This reasoning encourages loyalty to many ITs too.

Second, ITs often have revenue reserves, and some can use their structure (for example, cheap debt or ZDPs) to boost income yield. The importance of smoothing dividends can be overstated and a long-term policy of turning capital into income at the margin is hardly tax efficient.

However, IT income reserves can mean a manager can buy a stock that does not meet an income target this year in the expectation it will do well over three or four years. That extra flexibility can be useful, particularly if (as today) many equities yielding 5% look expensive compared to those yielding 3%.

Third, ITs are often the best ways to invest in niche areas, particularly if liquidity in the underlying assets is a problem. This matters a lot at the moment.

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