The swift rise in interest rates over the past 20 months has led to many previously attractive income-focused investment funds falling out of favour, though there are several investment trusts that have prospective yields well above the rates offered by even the most generous savings accounts.
Many investment funds that were previously seeing much higher demand due to their attractive dividend yields are now languishing on sizeable discounts, analysts at Stifel observed in a note on Wednesday, especially trusts investing in 'alternative assets' (i.e. assets that are not equities).
"Given current high risk-free rates, we wonder if funds where income is a core focus of their return profile are offering dividend yields that are high enough relative to other asset classes," wrote analyst William Crighton.
Top of the list of income-focused funds ranked by dividend yield are Marble Point Loan Financing Ltd (LSE:MPLS), Chenavari Toro Income Fund Ltd (LSE:TORG) and Fair Oaks Income (LSE:FAIR), yielding 18.6%, 16.1% and 15.2%.
Next are a group all yielding between 10% and 12%: Digital 9 Infrastructure PLC (LSE:DGI9), VPC Specialty Lending PLC (LSE:VSL), Henderson Far East Income (LSE:HFEL), CQS New City High Yield (LSE:NCYF), Volta Finance Ltd (LSE:TVA), followed by a group of renewable energy funds including NextEnergy Solar Fund Ltd (LSE:NESF) and Harmony Energy Income Trust PLC (LSE:HEIT), yielding 9% or more.
For some, such as Chenavari and Henderson Far East, their 3-years NAV growth is negative (-23% and -30% respectively), and so the analyst said the list highlights some cases where the current dividend yield may not be considered sufficient when considering recent capital growth performance.
When interest rates were sub-1% and most income-focused investment funds yielded at least 5%, the income alone was "sufficiently attractive by itself to justify investment" and any capital growth was viewed as “icing on the cake”.
Different approach required
But as the backdrop has evolved such that investors have to now take a view on total returns, that is income plus the prospect of capital growth, "this requires a markedly different approach", said Crighton.
"While one could argue that we should compare income in the context of long-dated government bond yields (let’s say the UK 10-year yield of 4.7%), this ignores the reality that many investors have to justify decisions on a more short-term basis."
While the level of the peak UK interest rates is now likely to be higher than expected at the start of this year, the analyst said he still firmly believes that it is "unlikely" rates can remain at these lofty levels given pressures on the consumer, and there will be "some lowering" in 2024.
"Many of the listed alternative funds aim to provide a level of income over many years and these yields may begin to look more attractive again when income returns decline on other asset classes," he said.
Attractive discounts
Either way, in several cases, the Stifel team sees the dividend yields on offer as "attractive", such as from collateralized loan obligation (CLO) funds and direct lending funds, such as Fair Oaks and CQS New City.
In other cases, fund or sector-specific issues have led to some funds trading at significant discounts, bolstering the dividend yield, assuming the dividend is maintained, Crighton said.
D9 Infra is, for example, on a 54% discount with an 11.7% yield, while Cordiant Digital is much lower down the yield ranking due to the lower dividend target.
"This highlights the need for the manager to make a much stronger case on its capital growth narrative than is currently the case," the analyst said.
Taylor Maritime's 42% discount is partly due to concerns about weaker growth in China, but it currently yields 8.9%, while the highest-yielding conventional fund investing in solely listed equities is Henderson Far East Income (LSE:HFEL), with an 11.4% yield but the cost of this being a poorly performing portfolio.
The renewables funds offer an average 7% dividend yield, the analysts noted, topped by NextEnergy Solar.
US Solar also has a relatively high yield of 9.1% though this is bolstered by the larger discount of 35% due to company specific issues, it was noted, such as the investment management team changing.
At the lower end are The Renewables Infrastructure Group Limited (LSE:TRIG) at 6.9%, Octopus Renewables Infrastructure Trust PLC (LSE:ORIT) (also 6.9%), Greencoat Renewables PLC (LSE:GRP) (6.8%), Greencoat UK Wind PLC (LSE:UKW) (6.6%) and Downing Renewables & Infrastructure Trust PLC (LSE:DORE) (6.4%).
"Though, capital returns over the past three years have been strong across the renewables spectrum."
The energy storage funds highlight that both Gore Street and Harmony Energy appear cheap on an income basis as both yield more than 7%.
However, the analyst noted that Gresham House Energy is significantly lower down the list with a yield of only 5.9%, which "implies that investors would have to take the view that the capital growth narrative on Gresham House Energy is much stronger versus its peers for it to justify an investment at current levels (to date, since IPO, this has been the case), or the dividend targets at its peers are too high".