Comment: High yielding investment trusts

4th Feb 2011 15:31

With most bank and building society savings accounts offering derisory interest rates these days it is tempting to look to other forms of investments to boost income. If you want higher returns, however, then you usually have to accept higher risk of losing your capital, though there are ways of reducing this risk.For equity investors, the temptation might be to pick one blue-chip stock paying a chunky dividend and pile into that but, as was seen last year with BP, no matter how safe and secure a stock's dividend might seem, events can force a quick change of dividend policy in even the mightiest of companies.The old adage of not putting all your eggs in one basket is appropriate when it comes to reducing risk, but not every equity investor wants to pay all the dealing costs involved in building an income portfolio of, say, a dozen high yielding stocks. For investors such as these, high income investment trusts might be the solution. In this scenario the investor buys just one or two investment trusts, safe in the knowledge that those trusts - sometimes referred to as "pooled investments" - have themselves invested in literally dozens of shares. In other words, if you buy shares in an investment trust that has a portfolio of 30 stocks then you are investing, by proxy, in 30 stocks rather than just one.Stockbroker Oriel Securities has done a lot of the spade work in terms of working out which are the highest yielding investment trusts that invest primarily in equities. It's top four comprises:1) Shires Income - dividend yield (DY) of 6.3%2) Merchants Trust - DY 5.5%3) European Assets - DY 5.5%4) Majedie Investments - DY 5.5% Just below this four are four more trusts each yielding 4.7%: Dunedin Income Growth, Edinburgh Investment Trust, INVESCO Income Growth and Shires Smaller Companies.For comparison purposes, Oriel observes that the FTSE 100 index has a composite dividend yield of 2.9% while the FTSE 250's yield is even lower at 2.2%."Many of these trusts have substantial dividend reserves which can be used to maintain or increase dividends at times when the dividend payable is not fully covered by annual revenues. We see the ability to use revenue reserves as an advantage that investment trusts have over some other investment products," Oriel's broker note states.As Oriel's comments about the importance of cash reserves implies, just blindly investing in the highest yielding trust is not necessarily the best way to go about things, as there are other factors to take into account, such as the trust's share price versus its net asset value per share (NAV); a share trading at a deep discount to its NAV could indicate that the trust is undervalued, while a trust trading at a premium to its NAV could suggest that the market rates the management highly. Of course, the reverse also applies.Other things to take into consideration before taking the plunge is the sort of investments a trust makes. Some focus entirely on UK equities, others on other parts of the world, some on big caps, some on small, while there are also trusts that focus on particular sectors, such as property.As they like to say on the investment bulletin boards, "do your own research"; all the tools available to do so are available on Digital Look.