High-yield trusts investors are buying that beat top savings rates

interactive investor customers have been turning to investment trusts with high yields, at the same time as bond yields and savings rates rise.

For the first time in several years equities have competition from higher savings rates and bond yields. Both have risen in response to higher interest rates as central bankers attempt to cool red-hot inflation.

At the time of writing, the top-paying one year fixed-rate bond is 4.75%, according to Savings Champion. If you want to lock up your money for a longer period, the top rates range between 4.75% and 5%.   

In the bond market, investors can pocket yields that start at around 4% for the safest type of debt. The 10-year UK government bond (gilt) yield is 4%, compared to 1.14% a year ago.

• Explore: ii Super 60 Investments |  Transferring an Investment Account | Free regular investing

Gilts are the ultimate low-risk investment due to the security of the issuer – the UK government – which is very unlikely to go bankrupt.

With higher income available from cash and bonds, the ‘TINA’ strategy (there’s no alternative to equites) is no more. Various commentators have cited TINA as the reason for the strong performance of equity markets over the past decade.

As a result, investors may now be giving greater consideration to cash and bonds, particularly those who are on the hunt for income. 

• Why Britain’s best defensive trusts own so many inflation-linked bonds
• Ask ii: can I get a yield of 4% or more from bonds like I can from equities?
• Ian Cowie: 11% yield and out of favour, time to top up

There’s certainly something to be said for having some of a portfolio in cash. The underlying capital is secure, whereas with the stock market capital is at risk. Also, having some cash to hand makes sense tactically, so that you can have a “war chest” to take advantage of stock market sell-offs.

And when those sell-offs occur bonds usually come into their own and provide defensive ballast. While this has not played out year-to-date, with shares and bonds falling in unison, over the long term a combination of the two asset classes has historically reduced risk. In 2022, the unusual combination of interest rates rising while the economy slows, has caused bond prices to fall at the same time as stock markets.

The silver lining to a fall in bond prices is that bond yields have risen. For new investors, this offers the opportunity to take advantage of the most attractive income levels in a long time. The income that bonds pay, which is fixed and therefore more reliable than dividends promised by equities, is a key attraction for investors.

• Where markets go next as the summer rally stalls
• Jeremy Grantham: ‘Prepare for an epic finale of the superbubble’

However, while equities are higher risk, there’s the prospect of higher rewards over the long term, and benefiting from capital growth as well as dividend returns. In contrast, the rate on cash savings and bonds is fixed, meaning there’s no possibility of a higher return.

Over the long term, stock market returns have outpaced cash in real terms after factoring in inflation, and the key driver has been dividend growth.

The high-yield funds and trusts investors have been buying 

In response to higher interest rates, interactive investor customers have been on the hunt for income. Analysis of the top 20 most-bought active funds and investment trusts (from the start of the year to 26 September) found a notable year-on-year increase in popularity for dividend strategies.

This was most prevalent with investment trusts. Over the same time period in 2021, there were just two dividend-focused trusts in the top 20: City of London (LSE:CTY) and F&C Investment Trust (LSE:FCIT).

A year on, the duo are joined by five other income trusts in the top 20: Greencoat UK Wind (LSE:UKW), Gore Street Energy Storage Fund (LSE:GSF), Merchants Trust (LSE:MRCH), Henderson Far East Income (LSE:HFEL), and Murray Income Trust (LSE:MUT).

Each trust, asides from F&C, which has a lowly yield of 1.5%, are offering starting income near to or above 5% - ahead of the top-paying one year fixed-rate bond.  

While F&C is a “dividend hero”, having increased its dividend for 51 consecutive years, the global multi-manager trust is more of a growth than an income proposition.

The highest yield is the 9% on offer from Henderson Far East Income, followed by Gore Street Energy, Merchants and City of London, yielding 6.5%, 5.4% and 5.3%. The latter two trusts mainly invest in large-cap companies in the FTSE 100 index.

The remaining two trusts – Greencoat UK Wind and Murray International – have yields of 5.4% and 4.7%. Greencoat UK Wind aims to increase its dividends in line with retail price index (RPI) inflation, which has become a greater attraction given the backdrop of inflation at its highest in decades. 

The same trend played out for funds, although the yields are lower. Over the same nine-month period in 2021, there were no dividend strategies in the top 20 most-bought active funds. There are now three: FTF ClearBridge Global Infrastructure Income (yielding 4%), Fidelity Global Dividend (yielding 2.7%) and VT Gravis Clean Energy Income (yielding 3.9%).

FTF Clearbridge Global Infrastructure Income seeks to outperform the Organisation for Economic Co-operation and Development G7 Inflation index by 5.5% over an investment time frame of five years.

While high yields look attractive on paper, it is important to remember that there are no guarantees that they will result in market-beating returns from a total return perspective – when both capital and income are combined.

In addition, dividend growth may also turn out to be more subdued versus a lower-yielding trust.

Why investment trusts are more consistent income payers than funds

Investment companies’ ability to hold back up to 15% of the income they receive each year in a revenue reserve gives them an advantage in delivering consistent income to investors over funds. In contrast, funds have to distribute all the income generated by the underlying investments each year.

The investment trust structure came into its own during the global financial crisis and again during the Covid-19 pandemic. Boards dipped into their reserves to top up income shortfalls from underlying investments so that they could maintain their long track records of raising their dividend year in, year out.

In total, there are 17 investment trusts that have increased their dividends for more than 20 years.

However, when sizing up these ‘dividend heroes’ an important consideration for income seekers is that not all of them have attractive yields. Some have yields of below 2%, which is not much to write home about. Instead, the lower-yielding trusts have a greater focus on growth over income, which is important to bear in mind.

• City of London outpaces its benchmark and ups dividend
• Video: three cheap shares I’ve bought for City of London Investment Trust

City of London investment trust is one of interactive investor’s favourite options for income seekers and appears on its Super 60 list of investment ideas. The trust is managed by experienced hand Job Curtis, who has been at the helm since 1991. It is a consistent performer, with Curtis adopting a conservative approach in focusing on companies with good cash generation. It mainly sticks to the dependable, larger-company FTSE 100 dividend-payers. Its revenue reserves per share account for around 40% of the annual cost of dividends. So, there’s a safety blanket in place, which should offer some comfort to investors.