It is possible to build a monthly UK equity income portfolio yielding more than 4 per cent and with a 19-year track record of dividend increases using just three investment trusts: City of London, Schroder Income Growth and Perpetual Income & Growth.
There are numerous trusts in the AIC universe with a relatively high yield and a strong record of dividend increases. However, while each one represents a good base for an income portfolio, the vast majority of these trusts pay out to shareholders on a quarterly basis.
This means you need to be effective at budgeting, resisting the urge to blow three months’ earnings in a matter of weeks; or you need to build a complementary portfolio of trusts that pay their dividends in different months.
The Income Finder, a new tool from the AIC, should simplify the act of building a monthly income portfolio of investment trusts.
Here we take a closer look at the three named trusts.
City of London holds the joint record for the highest consecutive number of years it has increased its dividend, at 52. In Job Curtis, it also has one of the longest serving managers in the AIC universe – he took charge of the trust in July 1991
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Although he pays some attention to macroeconomic factors, Curtis (pictured right) takes a predominantly valuation-driven bottom-up approach, starting with the share price and dividend yield and weighing these up against the company’s prospects.
“The key thing is I need the companies to both be able to afford their dividends and also have enough cash to pay for capex, because unless a company is investing for the future, it won’t be going forwards,” he said.
The portfolio targets a yield of between 10 and 30 per cent above the UK market, which the manager said is in the “sweet spot” that allows him to balance dividend growth and a decent yield.
Data from FE Analytics shows City of London has made 244.33 per cent over the past decade compared with gains of 232.02 per cent from its IT UK Equity Income sector and 184.04 per cent from the FTSE All Share index.
Performance of trust vs sector and index over 10 years
Source: FE Analytics
The trust has ongoing charges of 0.41 per cent and is yielding 4.31 per cent. It is on a premium of 1.25 per cent compared with 1.66 and 1.63 per cent from its one- and three-year averages. It is 9 per cent geared.
City of London pays its dividend in February, May, August and November.
Schroder Income Growth aims to deliver growth of income above inflation and capital growth as a consequence of the rising income. It has traditionally been managed with a value approach, although it has become more growth orientated since manager Sue Noffke joined in July 2011
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Having said that, Noffke (pictured left) has been increasing her exposure to the domestically focused area of the UK equity market over the past year, saying this has become the most undervalued sector since the vote to leave the EU in 2016.
In a recent article on FE Trustnet, the manager said: “We have a bottom-up fundamental process of evaluating opportunities. And we did a lot of sitting on our hands and looking at where those opportunities might arise, but really towards the end of 2017 and 2018 we felt that the valuation opportunity particularly in domestics was so compelling we couldn’t wait any longer.”
The manager is optimistic about the prospects for the UK market overall, pointing out its yield was almost double that of its global counterpart at the start of the year.
“On a 12-month forward basis at the end of 2018, UK equities were yielding 4.8 per cent,” she explained.
“It would take either a cut of 25 per cent of dividend income to get you back to the 30-year average of 3.5 per cent, or a rise in the UK equity market of over 35 per cent. It may be a combination of the two.
“Just to put it in perspective, the cuts that we saw in dividend income for UK equities in the financial crisis were a cumulative 15 per cent. And so we are discounting a situation much worse than that.”
Schroder Income Growth has made 96.92 per cent since Noffke joined compared with 88.52 per cent from its sector and 72.72 per cent from the FTSE All Share.
Performance of trust vs sector and index under manager tenure
Source: FE Analytics
It is on a discount of 7.72 per cent compared with 6.9 and 7.91 per cent from its one- and three-year averages.
The trust is yielding 4.15 per cent and has an OCF of 0.93 per cent. It is 15 per cent geared.
Schroder Income Growth pays its dividends in January, April, July and October. It has raised its dividend in each of the past 23 years.
Just missing the list of Dividend Heroes – it has raised its payout to investors in 19 consecutive years, rather than 20 – is Perpetual Income & Growth. This trust is headed up by FE Alpha Manager Mark Barnett who, like his mentor Neil Woodford, has been through a challenging period recently – Perpetual Income & Growth is down 0.3 per cent over the past three years compared with gains of 36.24 per cent and 28.43 per cent from its FTSE All Share benchmark and sector, respectively.
Performance of trust vs sector and index over three years
Source: FE Analytics
However at the start of 2019, analysts at Winterflood pointed out Barnett outperformed in 14 of his first 16 calendar years as manager, meaning a buying opportunity may have opened in Perpetual Income & Growth.
“The prolonged period of underperformance can be broadly explained by multiple factors,” said Winterflood. “These include: a number of specific stock disappointments; the headwinds facing some sector calls, such as tobacco; and a preference for UK domestically orientated companies that have been out of favour given the uncertainty surrounding Brexit.
“Despite this decline in performance, Barnett’s investment approach, which is shared across the wider team, is unchanged.”
“However, in a year when we have seen increasing scrutiny of the manager’s record, we remain confident in Barnett’s ability as a stockpicker over the long term.”
Data from FE Analytics shows Perpetual Income & Growth has made 169.12 per cent over the past 10 years, compared with gains of 232.02 per cent from its sector and 184.04 per cent from the FTSE All Share index.
It is yielding 4.36 per cent and has an OCF of 0.73 per cent.
The trust is on a discount of 12.4 per cent compared with 11.29 and 8.86 per cent from its one- and three-year averages and is 16 per cent geared.
It pays its dividend in March, June, September and December.