Many of the highest-yielding portfolios are trading on large premiums to net asset value [NAV], which is risky in itself, Tan warns.
However, it is the lack of cover of the dividend and reliance on debatable assumptions that makes it important to dig under the surface of some of those with the highest payouts, he claims.
“It feels like a lot of people are buying some of them because of the high yields without thinking of whether that yield is covered,” he said.
“There are some themes that stand out: healthcare, real estate and infrastructure.”
Tan says that in these areas, investors are displaying a strong appetite for a number of trusts that aren’t earning enough to cover their dividend, making them reliant on reserves and future earnings growth to maintain their payout.
In addition, some of the funds buying long-lived assets that are seen as dependable and therefore desirable are building in assumptions to their valuation models that are questionable, he warns.
While income-yielding equities are likely to be supported by a growing number of retirees, investors need to look for well-covered payouts and be wary of trusts sensitive to interest rate changes like the sectors under consideration.
Here are five funds that investors may wish to consider switching out of.
Medicx
This £278m trust became a favourite with multi-managers for the apparently stable nature of its yield.
It invests in GP surgeries and other primary healthcare sites which it lets to health authorities.
The trust is paying out a 7 per cent dividend, but Tan warns that this is not covered.
“In terms of the dividend it’s paying, I doubt it will ever be covered,” he added.
In total return terms the trust has done well over three years relative to the sector, but the last year has shown a convergence of performance.
Medicx has made 16.37 per cent while the average specialist property trust 11.64 per cnt, according to data from FE Analytics.
Performance of trust vs sector over 1yr
Source: FE Analytics
The trust is trading on a premium of 14.5 per cent, which Tan suggests is too high. Ongoing charges are 2.86 per cent inclusive of a performance fee.
It is a top-10 holding in Premier Multi Asset Monthly Income, CF Stewart Ivory Investment Market and Architas MA Active Reserve.
UK Commercial Property
“The UK-based property investment trust sector as well is looking expensive,” Tan said, giving the example of Ignis UK Commercial Property.
The £922m trust is yielding 6.8 per cent but is trading on a hefty 12.8 per cent premium.
“It has only 70 or 80 per cent cover as well,” Tan said.
Data from FE Analytics shows that the fund has made 23.42 per cent in total return terms over the past 12 months, with a noticeable tailing off of performance relative to the sector in the second half of the year.
Performance of trust vs sector over 1yr
Source: FE Analytics
The trust has ongoing charges of 1.59 per cent and is a top-10 holding in CF Heartwood Cautious Income Multi Asset and Premier ConBrio Managed Multi Asset.
Doric Nimrod
The Doric Nimrod funds lease aircraft and use the proceeds to pay out an income to investors.
“You are buying a bunch of Airbus 380s and you are making a few aggressive assumptions to get to the 7 or 8 per cent yield figure over the life of the aircraft,” Tan said.
He explains that the managers of the trust are very aggressive in their estimate of the value that the aircraft will have at the end of their lease period when they will sell them on.
“It’s a very specialist aircraft and it’s hard to see a significant market when they want to sell it on,” he said.
“They are taking an aggressive view on how little depreciation there is going to be on the planes.”
There are three funds trading between a 17.6 and 30 per cent discount. CF JOHIM Alternatives holds the Doric Nimrod Two fund in its top 10 as does the Thesis KES Income & Growth fund and the Baring Portfolio fund.
GCP Infrastructure Investments
This £315m trust invests in UK infrastructure projects, many of which have a renewable energy focus.
“They recently lowered the discount rate they use to calculate NAV, giving a higher value for current NAV,” Tan says.
It is yielding a healthy 6.8 per cent but trades on a 7.2 per cent premium, and Tan says this, along with the generous discount rate, means investors should tread carefully.
Our data shows it has made 26.4 per cent over the last three years while the average infrastructure trust has made 16.8 per cent. Over the last year the trust has performed roughly in line with the sector, however.
Performance of trust vs sector over 1yr
Source: FE Analytics
The trust has ongoing charges of 0.7 per cent. It is a top-10 holding in three funds in the CF GHC Resilient series and in CF KB Ramogan.
Japan Residential Investment
This £129m trust invests in Japanese residential buildings that are rented out to private owners.
It is currently trading on an 8.3 per cent premium, and pays out a healthy yield of 6.9 per cent.
“I remember it trading on a 20 to 30 per cent discount two years ago,” Tan said. “Then they reviewed their dividend policy and now it pays out 6 per cent. On a 52-week view, the average discount is 24 per cent.”
Tan says that investors should be wary of such a sudden jump in valuation.
Our data shows the trust has seen a massive re-rating in recent years, returning 57.39 per cent over the past three.
Performance of trust vs sector over 3yrs
Source: FE Analytics
The trust is a top-10 holding in the CF Miton Strategic Portfolio and CF Miton Total Return as well as the EFA OPM Property fund. It has ongoing charges of 6.45 per cent.
