Investing for income is not just about picking the shares with the biggest yields.
A glance down the FTSE 100’s list of big payers is enough to reveal that there are some hefty payouts on offer from its corporate giants, but plenty of risks that may be lying in wait too.
So how can you combine investing for high income with dodging the dividend traps?
David Smith, of Henderson High Income, joins us on this episode of the Investing Show to explain how his investment trust aims to do that for investors.
It predominantly invests in shares, but the trust also has about a fifth in corporate bonds and currently yields 5.3 per cent.
Some of the Footsie’s big hitters are in Henderson High Income’s portfolio, but it also holds a number of FTSE 250 firms, including National Express and Britvic, which the manager says have solid single-figure growth that makes them an income prospect for years to come.
But why does it also hold bonds? Particularly at a time when there are concerns over low yields and high prices and regular forecasts of a bond market crash?
David says that the trust holds them to boost the income it can get, which means it doesn’t need to chase high yields on shares that risk a cut.
Potential investors in Henderson High Income should be aware that risk is raised its use of gearing – as investment trust borrowing is known – to buy bonds and boost their yield further, although the manager says it mitigates some of that by targeting non-cyclical big name companies, such as Amazon, Tesco and Virgin Media.
The trust is careful not to rely too heavily on the narrow list of companies that pay out a lot of the UK stock market’s dividends.
To highlight that David explains that the top 20 UK dividend payers contribute 74 per cent of the stock market’s income, whereas for the trust that top 20 – not all of which it holds – make up 37 per cent of its income.
‘The one thing about dividend yield,’ says David, ‘is that in isolation it can be a completely misleading guide to value and it could be illusionary’.
‘The reason why dividend yields are so high is probably the market’s telling you those dividends are unsustainable in the longer-term.’
When looking for dividend shares, he says it is important to look for three key measures of robustness: dividend cover, cash flow and balance street strength.
Henderson High Income has ongoing charges of 0.81 per cent and has a total return of 14.8 per cent, 17.9 per cent and 28.8 per cent over one, two and three years, respectively. By comparison, Vanguard’s FTSE UK All Share tracker fund, which does not invest in the same stocks or bonds, has returned, 9.4 per cent, 17.5 per cent and 34 per cent, over the same periods.