Income trusts for 2023 and big discounts that catch my eye

These are the investment trusts that income seekers should consider in 2023, believes Thomas McMahon, investment trust research manager at Kepler Trust Intelligence. He also names the interesting trusts currently trading at a big discount.

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Lee Wild, head of equity strategy, interactive investor: Hello, with me today, I have Thomas McMahon, investment trust research manager at Kepler Trust Intelligence. Hi, Thomas.

Thomas McMahon, investment trust research manager at Kepler Trust Intelligence: Hi Lee.

Lee: Good to see you again. Thomas, for those of us who want to invest for income over the next 12 months, which investment trusts do you think we should all be looking at?

Thomas: Well, I think the pandemic period has really highlighted the strengths of investment trusts for income, and that's reflected in relatively narrow discounts in the UK income sector. I think of the equity income trusts City of London Ord (LSE:CTY) really stands out as having absolutely rock-solid revenue reserves and just continues to generate good income. And as I'm speaking, the dividend yield is around 5% or so, and it's done that year after year after year and has performed very well on a total return basis this year in 2022.

I think if you're looking for higher income, there are some you can take a bit more risk in equities and CT UK High Income Ord (LSE:CHI) stands out. It's got a bit of an innovative structure that allows the ordinary shareholders to receive an elevated dividend, some capital growth shares that don't. So, you know, I think there's a couple of examples, but frankly, the sector as a whole looks very interesting in terms of dependable income. I guess the question for investors is whether it's enough pick up over cash. So, you know, that depends a lot on what we see in interest rates over the coming years. But I guess with equity income, you have to bear in mind that you've got dividend growth prospects.

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• Watch other video with Thomas McMahon: Four investment trusts to make big profits in 2023

The UK-facing businesses in the 250 and so on have taken a more significant hit. The FTSE All-Share has done relatively well this year, but the 250 is down, the small caps are down. There's a potential for some for earnings growth and income growth over the long run, which maybe makes equity income an interesting place to look. I think, you know, alternatives, you can get a higher yield. The question at the moment is people are a little bit concerned about valuations and whether the NAVs fully reflects recent interest rate increases. But from an income perspective, that may not matter if you're holding for the long run and then you can get a much higher yield.

I think something that looks quite interesting to me at the moment, and it's a trust called M&G Credit Income Investment (LSE:MGCI). So, this largely invests in floating rate loans and bonds, which means that the coupons it receives increase as interest rates increase. And so what that means is that the current historic yield understates, in my view, what the income is going to be, particularly as this trust will pay up a larger dividend at the end of the financial year based on what's happened over the year. So, I think at times yielding in the fours, but I would expect that you would get a higher yield than that from something that should be relatively defensive. So it doesn't have a lot of interest rate exposure at all. It does have some credit exposure so it's not risk-less, but I think again it's another interesting place to look for income.

Lee: So, Thomas, after a big stock market correction in 2022, plenty of investment trusts are trading on significant discounts to asset value. Are there any heavily discounted sectors or individual trusts that catch your eye?

Thomas:I think the discounts have largely been relatively rational so far. So the things that have moved onto the biggest discounts have been the things that have the greatest rate sensitivity, the greatest duration and the greatest gearing. So that would be property, real assets, growth stocks. I think things that stand out as looking a little bit overdone, would be private equity.

• Watch other video with Thomas McMahon: Scottish Mortgage investment trust: prospects for 2023
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Private equity, is a bit of a complex area, bit illiquid, it uses gearing. The trust does tend to have a reasonable discount on that and they have done for quite some time. It doesn't really seem reasonably in the good times, but over the last year, those discounts moved out to say 35 or 40% in many cases, and that just seems a bit too much. It is quite likely that we'll see valuation declines reported in the coming quarters, but that seems like a pretty substantial cushion. So that's an area of interest. But I do think investors need to in particular dig into the gearing situation with those trusts, make sure they fully understand that before investing. But I think that's an area that does look pretty interesting. Beyond that in more conventional sectors, I mean the discounts aren't extreme at the moment, but UK small caps on 10 to 15% or so, they've been wider during the year, but I still think this is a very good long term growth market. And that's quite a nice extra return if you've got a long enough holding period. So that's an area I think that's quite interesting.

Lee: Are there any trusts in that sector that stand out for you?

Thomas: Discount-wise, I mean, it will move around day to day. But, you know for a value focussed investor, Aberforth is trading on a double discount, a double-digit discount at the time of speaking, so that's quite interesting growth investing. BlackRock Smaller Companies Ord (LSE:BRSC) are also trading on a significant discount. I mean I think there's a lot of quality portfolios in that sector and most of them are on wide discounts. And I think, you know, that sector has a track record of the discounts narrowing when times are good, so you know it may not come for some time, but you've got a long-term perspective that could be quite interesting.