The increased issuance of investment trust income shares is producing higher and higher headline yie...
The increased issuance of investment trust income shares is producing higher and higher headline yields but with increased amounts of risk.
So far this year £254m worth of income shares have been issued, yielding between 8% and 10% per annum.
Managers have been able to become more selective when it comes to purchasing the paper. They are testing to see the downside potential of these higher risk issues although they welcome the greater diversification of the market.
Richard Prvulovich, manager at Investec Guinness Flight Income Share unit trust, says: "The fund is fully invested so any new issues will have to be extremely attractive to interest me. Having said this, the Murray Johnstone Japan Growth & Income trust looks to have a sensible structure and I was impressed by Graeme Sinclair who will manage the Japanese equity part of the portfolio. My only two reservations are that the management charges look quite high and there is a continuation vote in 10 years but the bank debt is repaid after seven, which seems strange."
The Close Brothers UK index tracker, launched in July, has added something new to a sector looking for diversification, according to Prvulovich. He says: "Though it invests in UK stocks as with the majority of split caps, it follows an index which means it carries a slightly lower risk of underperforming."
One of the problems for the sector that Prvulovich identifies is a general switch in equity markets away from providing income to offering capital gains. Prvulovich says: "Some managers have been investing in a narrow range of stocks, usually in the utilities and financials sectors, to achieve high levels of income.
"When I look at income shares I don't always go for the ones offering the highest yields more important is the diversification of the underlying portfolio. I prefer blue chip split cap income shares to those which invest in other split cap trusts. These kind of shares are implicitly geared on gearing which produces a larger risk element."
The CF Goy High Income unit trust has only one holding of income shares in its portfolio INVESCO Geared Opportunities. David Goy, manager of the fund, believes income shares are currently not offering good value and are high risk.
He says: "The hurdle rates on the current batch of new issues seem a little high. In the low inflationary environment that we are in, returns on equities will be relatively low. As a result, managers should find it increasingly hard to beat benchmarks to achieve hurdle rates. We will, therefore, see them take more risks."
Though not attracted to the new issues of income shares which invest in equity, Goy is considering investing in high yield bond funds, such as INVESCO Leveraged High Yield Bond fund. He is also looking to reduce his cash position and build up exposure to income shares with a track record.
He says: "As returns on equities will be relatively low, a fund invested in bonds seems a far safer option and they also offer attractive yields, at around 10%."
In 1996 around one-third of Goy's portfolio was exposed to income shares, a figure which he believes helped fuel the fund's good performance. Goy says: "In 1996 income shares were ridiculously cheap. As their price has increased, I have been taking profit. Now the portfolio is biased towards preference shares from the Halifax and CGU."
The portfolio in Investec's High Income fund has around 60 stocks, 95% of which are income shares and 5% are capital and zero dividend preference shares. Prvulovich says: "The reason why the portfolio is not fully invested in income shares is that it holds some annuity income shares which do not provide any capital gain at all."
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