Star manager Steve Russell believes investors should be watchful of a bubble forming in equity income stocks, which would be a particularly heavy blow to trusts like the Edinburgh Investment Trust and Murray International Trust.
However, Drake says the immediate risk to these trusts is minimal.
“There’s always a risk of premiums disappearing suddenly, but in equity income – particularly for those trusts focusing on the UK – I don’t think there is anything to worry about at the moment,” he said.
“These trusts are popular because of their attractive yields relative to interest rates, and there’s nothing to suggest that rates are going anywhere for a long time to come.”
“When there are rumours of the government changing their policy then of course the risk increases – one look at the average discount of these trusts shows that the premium is likely to go down at some point.”
Drake also points to a trust's ability to control its premium, thus decreasing the potential for heavy losses if equity income were to fall out of favour.
“If, as some fear, premiums do start to go higher and higher, trusts can issue shares and therefore bring down the premium,” he explained. “This is a very useful weapon to counteract the risk.”
A recent FE Trustnet study highlighted a selection of trusts that use discount control mechanisms, which dampen the threat of discount volatility.
According to data from the AIC, the average trust in the IT UK Growth & Income sector is on a premium of 0.5 per cent. Ten of the 23 portfolio in the sector are on premiums, including Neil Woodford’s Edinburgh Investment Trust, which is trading on +7.7 per cent, and the City of London Trust, which is trading on +3.8 per cent.
Performance of funds versus index over 5 years
Source: FE Analytics
Both five-crown rated portfolios have significantly outperformed their FTSE All Share benchmark over five years with less volatility, and both have a yield in excess of 4 per cent. They have a large cap bias, with companies like Vodafone, Glaxo and British American Tobacco making up a big chunk of assets under management.
Four of the ten funds in the IT Global Growth & Income sector – including Murray International and Henderson International Income – are on premiums, while the likes of Aberdeen Asian Income, Schroder Oriental Income and JPM Global Emerging Market Income are also trading above their net asset value (NAV).