Resist any temptation to give up on income trusts as interest rates rise

Stock market investment trusts offer scope for capital growth and inflation-beating dividend rises, says Robert Stephens

Rapid interest rate rises may prompt some income investors to question the merits of owning shares. After all, the Bank of England’s increasingly hawkish stance means that the yield on 10-year gilts currently stand at 3.1pc. Corporate bonds offer even greater returns, albeit with more risk, while it is easy to obtain an income of more than 4pc from bank or building society fixed-rate bonds over a five-year period.

By contrast, the FTSE 100 yields a rather modest 3.6pc. Investing in shares also comes with a risk of capital loss that is not there with gilts (if held to maturity) or cash savings. And because the stock market’s performance has historically disappointed during periods of rapid interest rate rises, the near-term outlook for shares is decidedly uncertain.

In Questor’s view, though, shares remain an extremely attractive long-term option for income investors. This is based on two main factors.

First, they offer the prospect of dividend growth that can keep pace with inflation. This would maintain the real spending power of income received over the long run. Second, shares offer the potential for significant capital gains. Certainly, their near-term prospects are challenging. But their long-term track record suggests that they are very likely to comprehensively outperform all other major asset types over the coming years.

The past performance of this column’s four stock market investment trusts highlights the appeal of shares over the long run. In aggregate, they have easily outperformed all other asset groups held in the portfolio since being purchased between 2016 and 2020. Their £21,925 capital gain amounts to a 20pc overall return, which is impressive given the difficulties experienced by the stock market since the start of the year.

Currently, the Schroder Income Growth trust trades at a 0.9pc discount to net asset value (NAV). Meanwhile, the discount to NAV of the JP Morgan Claverhouse trust is 0.7pc. The two figures suggest that the two quoted funds offer good value for money and further capital growth potential as the stock market gradually recovers from its present woes.

In terms of income, neither has a particularly enticing yield at present. The Schroder trust yields 4.4pc and Claverhouse 4.6pc, only slightly higher than the returns on some low-risk fixed-income assets or cash mentioned above. However, their historical dividend growth highlights the potential for them to provide an inflation-beating income return in the coming years.

The Schroder Income Growth trust has raised its dividend in each of the past 27 years. Over the past decade its dividends have grown by around 39pc. By contrast, inflation has been roughly 28pc in total over the same period. Similarly, the JP Morgan Claverhouse trust has raised its dividends for 49 consecutive years. Over the past 10 years its dividends have risen by 74pc.

Certainly, there is no guarantee that either trust will increase dividends by more than inflation in future. Indeed, their task is particularly difficult at the moment now that inflation is more than 11pc. But with excellent track records of consistent dividend growth and an easing of inflation expected to take place as interest rate rises ultimately prompt an economic slowdown, they are likely to deliver positive real-term increases in payouts for shareholders.

Of course, stock markets face an uncertain near-term outlook in view of a plethora of economic and geopolitical challenges. The share prices of both trusts could therefore come under further pressure following their single-digit declines since the start of the year. Since they use debt in an attempt to magnify returns, their share prices could be substantially more volatile than the wider stock market over short periods.

However, on a long-term view they offer an excellent choice for income investors as part of a diverse portfolio. Other assets may offer less risk and lower volatility. But for investors who seek a growing income and the potential for capital growth, both trusts are worthwhile holdings. For anyone with new money to invest, these trusts are a solid choice.

We’ll continue to hold both in our Income Portfolio.

Read Questor’s rules of investment before you follow our tips: telegraph.co.uk/go/ questorrules; telegraph.co.uk/questor