With interest rates still near historic lows, dividend investing has become a popular strategy to earn better rates of return. Yet just because you’re interested in high yields doesn’t mean that you’ll have to invest exclusively in slower-growing defensive sectors, such as utilities and telecoms.
There are a number of investment trusts that offer an attractive combination of both dividend income and capital growth. This is because following a rule change in 2012, UK investment trusts now have the ability to pay dividends out of capital profits. This means that they can invest in traditionally lower-yielding sectors, which may offer better than average growth prospects, and meet shareholder demand for income in the current rate environment.
UK smaller companies
One option is the Invesco Perpetual UK Smaller Companies Investment Trust (LSE: IPU). Aside from its dividend yield of 4%, this fund is a classic equity investment trust that holds a diversified portfolio of small to medium-sized UK quoted companies.
Unlike equity income funds, which invest primarily in higher-yielding stocks, this fund does not prioritise higher-yielding companies over lower-yielding ones. Instead, it remains focused on identifying what the managers regard as quality businesses with strong balance sheets.
But following a change in its dividend policy in 2014, it has used its capital reserves to supplement its dividend payments, in order to enhance its dividend yield. As such, the income earned by the portfolio in the form of dividends affords just roughly half of the investment trust’s yield.
Top performer
The fund is a top performer in the small-cap equity space and has been consistently beating the performance of its benchmark in recent years. It has a five-year total return of 50%, which compares favourably to the benchmark Numis Smaller Companies ex-Investment Companies Index’s gain of 28% over the same period.
Industrials is its biggest sector exposure, representing 33% of its total assets, and this is followed by consumer services, which accounts for a further 19%. The top five holdings in its portfolio include Coats, Clinigen, Consort Medical, Robert Walters and 4imprint.
Biotechnology
The biotechnology sector has been one of the hottest investment areas over the past decade, and many stocks have delivered incredible profits for investors. However, it’s an equity space which offers very low yields, with very many companies not offering any dividends whatsoever.
The International Biotechnology Trust (LSE: IBT) is one way to get around this issue. This investment trust offers a current yield of 4.1%, via the use of capital reserves to top up its dividends.
Unsurprisingly, its past performance is impressive. Over one-, three- and five-year periods, the biotech fund has returned 14%, 25% and 170%, respectively. However, past performance is no guarantee of future returns and it’s important to consider other factors as well.
Currency risk
Investors should also be wary about the impact of currency fluctuations on capital values. As US large-caps dominate its portfolio, and the underlying firms earn most of their revenues outside of the UK, the fall in the value of the pound in recent months has boosted the sterling valuation of its underlying investments.
Should the pound recover from such lows — perhaps from progress on Brexit negotiations, then the rise in the value of the pound would hurt capital growth in the future.