As global markets have enjoyed a rich run of form in recent years, to the benefit of growth investors, stable income has gradually become much more difficult to find.
The low interest rate environment that has helped drive up equity markets – not least in 2017, when indices and fund inflows hit record levels – has been to the detriment of both bond and equity yields. As a result, those searching for income have been left with a decision to make: do they stick with low-yielding mainstream assets, or take the plunge with riskier vehicles?
Some of those seeking higher levels of income have found the answer in debt trusts. These are closed-ended funds that invest in various types of debt, such as mortgages, peer-to-peer (P2P) loans and infrastructure.
Because of the illiquid assets involved, it is typically only investment trusts that are active in this space. Our analysis incorporates the Debt and Leasing sectors, as well as the Honeycomb P2P trust.
The optimum moment to buy may now be gone. Data from the Association of Investment Companies (AIC) shows the Sector Specialist: Debt cohort was the highest-yielding of all sectors at the end of September 2016 with an average payout of 6.9 per cent. It also found that despite these funds historically trading on premiums, share prices in the group had swung to a discount of 3.5 per cent, making them cheaper to buy.
Figures from a year later showed that the category had been knocked into second place by Sector Specialist: Leasing in terms of yield. The debt sector was still trading at a discount at this point, but this had narrowed to just 0.3 per cent. The leasing cohort proved much more expensive, trading at an average 21.1 per cent premium.
Debt trusts did at least still yield an average of 6.5 per cent. But tightening discounts mean shares are more expensive on average than before. But this trend could still encourage those looking for high yields at relatively low volatility, as it signals a brighter outlook.
Trading at premium levels
A report by Numis, published at the end of January 2018, showed that of the 38 funds across various debt sectors, 23 were trading at a premium, whereas 15 were on discounts.
Some types of debt were looking more attractive than others. All three funds investing in ‘distressed’ debt were applying discounts as at 25 January, with the highest in the group (not included in Table 1) just shy of 15 per cent. On the flip side, all four vehicles investing in real estate were trading on premiums of between 2 and 8 per cent.
The Numis report also highlighted individual winners and losers, including cases where investors “punished funds that failed to deliver against their yield or total return targets”. Whether to take additional risk in order to find higher yields – and whether these yields are sustainable – are key questions investors need to ask before introducing debt trusts to a portfolio.
