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View the article online at http://citywire.co.uk/wealth-manager/article/a740037

Nick Sketch: investment trusts with an edge in income

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

In part, this reflects that a lot of UK dividends come from about 20 shares. This doesn’t give much diversification, and few look very cheap today.

More generally, diversifying an equity portfolio is always important but is harder than it used to be, most obviously because cash and mainstream bonds offer very low returns.

Options for investments that should not behave much like equity markets over the next five years include niche fixed interest areas, commercial property and infrastructure. In all these areas, income yields of well over 4% are readily available. And in all these areas, the best investments will often turn out to be ITs.

Of course, we still need to think about valuation – discount swings bring volatility and can hurt even long-term investors, but this point alone makes many ITs worth investigation by income-seekers.

In fixed interest, liquidity constraints mean most unit trusts (UTs), particularly the most successful in asset-gathering, stick to mainstream bonds. However, the recent performance and return prospects of ITs such as Twenty Four Income and City Merchants High Yield , show there is a good reason for investors today to look beyond the obvious, even in fixed interest.

Investments like these will not behave like gilts, particularly over the short term, and we wouldn’t call them low risk. However, an investor who made the sensible decision a year ago to back the Invesco bond team by buying their main UT would have outperformed that fund’s peer group by a percent or two.

Someone doing a bit more work and deciding it was a good time to buy City Merchants instead would have added over 10% to the one-year return – so much for low returns from fixed interest.

Commercial property appeal

In commercial property, investors appear to have been very fearful of leverage a year ago, even though most of us are happy to gear property ourselves (we have mortgages).

A good year for net asset values has meant geared investments outperformed and got rerated, and most property ITs that look cheap today deserve their ratings. However, ITs still have some structural advantages for a long-term investor in property, whether they have high gearing or not – investors will not fund themselves locked in for a year or more if sentiment moves against the sector and funds do not need to hold 10% or even 20% in cash (as many property UTs do today).

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