Vodafone Group (VOD)


Focusing on quality names proves successful for high income trusts

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The high income category of the Money Observer 2012 Investment Trust Awards includes 13 trusts in the UK high income and global high income sectors and the ordinary income shares of 11 split capital trusts.

Our awards are based on three-year returns and cover a period that started soon after stockmarkets bottomed in March 2009 and ended before escalating worries about stuttering economic growth and the eurozone had led to markets giving back all or more of the gains achieved in the early months of 2012.

Henderson High Income Trust (HHI) is the only genuinely high-yielding contender to beat the group average in each of the past three years. In the process it has pulled well ahead of both the FTSE All-Share index and its own customised benchmark, which combines the All-Share with 20% in the Merrill Lynch Sterling Non Gilts index.

Unlike many of its peers, the trust managed to avoid cutting its dividend during the 2008/2009 market setback. As a result it provides a yield of more than 6%, paid quarterly. After a couple of years during which the board had to dip into revenue reserves, the dividend was fully covered last year, and manager Alex Crooke hopes it will be even better covered in the current year.

He says UK companies have been paying out only 35% of their corporate profits, compared to an historic average of 50%, so they have plenty of scope for lifting payments. However, the board has warned that revenue reserves must be strengthened before dividend growth is resumed.

As with most trusts in this grouping, Henderson High Income has substantial gearing, which contributed to a difficult time in the earlier financial crisis and has subsequently boosted its recovery. However, its gearing is lower than most of its competitors, and around half of it is offset by fixed-interest holdings. The trust's volatility has therefore been comparatively modest.

Crooke hopes that he can protect the trust from underperforming its benchmark during current market turbulence, partly because he expects his corporate bond holdings to hold up better than in the 2008 setback and partly because he has a lot of confidence in his equity exposure.

"The trust's equity portfolio is focused on quality names, like Diageo (DGE), Vodafone (VOD) and Compass (CPG), many of which have international businesses and which still look set fair, and good value," he says. "We have cut our medium to smaller company exposure to around 20%, as many of our holdings had had a good run and were looking fully valued. Also the higher-yielding UK smaller companies which suit our portfolio requirements tend to be more domestically oriented."

As a value-oriented investor, Crooke is more positive than many managers. "I think there is a good chance that the worst of the crisis in Europe will soon be over and that the UK economy could start picking up in the second half of the year."

Highly commended: Invesco Leveraged High Yield Fund (ILH)

This offshore company achieved stunning three-year net asset value returns, largely due to a stellar recovery in the year to March 2010, but it misses out on the top award because it missed the cut last year. It yields a mouth-watering 8.8%, which is covered and paid out quarterly. Manager Paul Read is confident it can be maintained. As the fund is Jersey based, the yield is paid gross.

Invesco Leveraged has had a very volatile history, due largely to its high gearing. Read says gearing has been reduced over the past few years because the board wants future returns to be steadier. It is nonetheless still sizeable at 40%.

Read and co-manager Paul Causer believe they have the ability to spot which bonds deserve more respect than their ratings imply. They are therefore prepared to have a sizeable exposure to junk bonds, as well as higher yielding investment-grade bonds.

The two Pauls have tended to favour financial issues. This proved very painful in 2008/09, but they stuck to their guns and were well rewarded. They still hold a lot of issues from banks, including UBS, Société Générale, Bank of America and Intesa, but contend they are mostly 'post crisis' thanks to balance sheet restructuring. They are comfortable to hold and buy on the dips.

"There is definitely a lot to worry about, including politics and event risk as seen at JPMorgan, but a lot is priced in," says Read.

Readers can track the progress of the award winners in the investment trust section of Interactive Investor. We hope they continue to outperform their benchmarks, and put passively-managed funds in the shade. A full explanation of the methodology behind the awards is available here.

13 trusts in the UK high income and global high income sectors and the ordinary income shares of 11 split capital trusts