Bargain hunter: High yield at big discount

For income seekers, there are 19 investment trusts offering yields of 4% plus, but in some cases dividends are far from guaranteed.

As recent research from stockbroker Stifel noted, the highest-yielding trusts tend to invest in the riskier parts of the market. This is evidenced by the fact that five of the trusts invest in Asia, the emerging markets or Latin America.

But some UK equity funds feature, including Dunedin Income Growth, managed by Jeremy Whitley and Ben Ritchie of Aberdeen Asset Management.

The trust, which is currently favouring the big blue-chips in the FTSE 100, yields 5.2%, while offering a discount of 10.2% - wider than the trust's one-year average discount of 7.9%.

Disappointing performance

This prompted Simon Elliott of broker Winterflood to say that the discount "offers value". He notes that one of the reasons behind the discount being wider than normal is the fund's "disappointing performance last year".

The trust lost 4.4% in 2015, versus a 1% rise for the FTSE All-Share index. Over the previous four calendar years that Whitley has been in charge, the trust has outperformed the index.

But its share price has lagged behind those of peers. Over a five-year time frame, the trust's share price has risen 25% versus 53% for the Association of Investment Companies UK equity income sector.

"We believe that Dunedin Income Growth provides core exposure through a UK blue-chip portfolio that has a lower exposure to mid- and small-caps than many of its peers," says Elliott.

"Its yield of over 5% is one of the highest in the peer group and we believe that the dividend is likely to be maintained given the projected revenue supported by revenue reserves."

Elliott thinks there is scope for the discount to tighten in the coming months, which would benefit investors who pick up shares today.

He says one way that the discount could fall into single digits is through improved performance. Another is the prospect of insurer Aviva selling back its stake in the trust to the manager. The insurer has been selling down stakes in some investment trusts, including Witan.

"In our opinion, this rating reflects the fund's disappointing performance last year and its Aviva/Friends Life holding (5 million shares, 3.3% of the share capital)," says Elliott.

"Aviva's legacy portfolio of investment trusts has been sold down recently, causing discounts for a number of funds to widen. If the trust's performance was to improve and Aviva's stake removed, we would expect the fund to be re-rated."

How we find investment trust bargains

Each month, Money Observer highlights a couple of investment trust bargains, both online and in our monthly magazine.

We will also occasionally draw attention to investment trusts that are "too hot to handle" - those that are trading on big premiums.

Our ideas come from regular conversations with investment trust analysts, and we will try to provide a mixture of bargains, from "hidden gem" trusts with less than £200 million in assets to the more established names that typically trade on a smaller discount or premium.

For the sake of simplicity, rather than using technical measures such as the "Z score", we will identify bargains by comparing current discounts with their 12-month averages.

Only those trusts with a wider discount than their average are considered. We will also look at the overall sector and the quality of the trust, and then take a view on whether the discount looks a good opportunity.

This article was originally published by our sister magazineMoney Observer here.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.