To be perfectly honest with you [hariseldon1958] I’ve become extremely neutral about this investment trust sector of late. I have the feeling that the train's somewhat left the station, so to speak. For having made steady progress back from UK market lows of July 2003 I think in my own often contrary way, that for the time being most of the capital gains have already been racked-up on many of these income oriented investment trusts. Which leads me to believe that sector dividend yields are increasing becoming less and less attractive (at least to me) relative to cash. The returning appetite of income hungry investors during this time has seen average discounts for these types of investment trusts contract from previously double to single digit figures. Such a phenomena is even more evident, in my view, when I look at current 12-month data for the sector that throws up many an example of share price out-performance v the progress of underlying net asset values. Clearly, a good few relationships between share price and NAV are currently operating outside the normal patterns of behaviour I have come to expect, relative to these investment trusts, and in my opinion, can’t be sustained unless discounts tighten even further.

If I were to be brutally frank with myself, when I established my holdings in Securities Trust of Scotland I underestimated big-time the negative effect of its borrowings on the fund manager’s ability to effectively marshal shareholder assets during the resulting UK market downturn which proved to be, if not overly severe in the historical sense then a lot longer than most had anticipated. However, thankfully due to long standing revenue reserves, the above average dividend payouts remained secure and at least kept pace with inflation throughout those difficult times. I personally think, in an effort at capital protection, Securities Trust of Scotland’s Board of Directors should have ‘bit the bullet’ much sooner than they did to reduce long-term borrowings down to a more manageable size. Though, in their defence, being able to securely maintain shareholder ongoing revenue streams was an overriding preoccupation for them during this period before they could get round to shedding a major proportion of debt from the balance sheet.

Although having to make up more ground than most, Securities Trust of Scotland’s past 12-month performance has seen a total share price return of 26% v that of 20% by the NAV that's been very much in-line with many of its peer group. Currently, with both a higher than average dividend yield of 4.4% and near 13% share price discount to NAV for the sector. I feel that the market is underrating its shares, though not by much, as investors wait for more positive signs of a NAV recovery following its recent debt reduction exercise.

From a more capital perspective than income, Murray Income’s done me proud of late due in no small part to being more focused on companies involved in the rally that’s been going on in shares just below the Footsie 100. Though, from where I’m standing, it appears the share price is now fully valued. Subject to this present market not getting too far ahead of itself by ignoring fundamental P/E ratios, I can’t see much more headroom remaining in the short-term. Though, one never can tell where the herd mentalities of stock markets are concerned.

While the yield attractions currently look reasonable and more importantly, sustainable to me. I personally [hariseldon1959] wouldn’t be comfortable with a portfolio mix that included Dunedin Income Growth, British Assets, Merchants and Securities Trust of Scotland for the simple reason there is too much structural debt on their combined balance sheets for my tastes. That’s not to say that in a rising market such long-term gearing could be disadvantageous, more than likely the opposite would be the case. However, if and when things get a bit rocky again or even just start going side-ways then the negative effects on a portfolio’s balance sheet of such long-term debt is much more difficult to neutralise than that of current lower interest short-term bank borrowing facilities.

For equity investors using investment trusts as vehicles to provide dividend streams either to draw upon or for reinvestment purposes. Income enhancing gearing, in some shape or form, be it via balance sheets or be it via share structures (i.e. split-capital trusts) is an ever-present fact of life. I wish it wasn’t so – but it is and therefore, requires an investor’s utmost attention as to any possible future capital impact on an asset’s ability to perform satisfactory. For I’ve gradually come round to the way of thinking that the older I get, the more wary of gearing I am becoming.

As I indicated at the end of a recent previous post on this TMF board: Number 5174 “Short-Term Investor Irrationality” dated 27/12/04. My intention to dispose of my considered overvalued and consequently under yielding holding in F&C Capital and Income once the share went ex-dividend has now been completed at an exit price of 197p.

What I’m currently looking into is, for me, a diversified income / dividend play further down the food chain than I normally go and for an initial minimum 4-year period with absolutely no prospect of any capital gain. Though, I’m in no rush to dive in just yet seeing as the next proposed ex-dividend date isn’t scheduled until June 16th.

Formerly known as Lloyds Smaller Companies, Smaller Companies Value Trust is a £45-Million split trust with two cases of share (income and capital) in equal proportion to one another. Currently being run out of Scottish Widows Investment Partnership by their smaller companies desk headed-up by yet another Scot, Gregor MacDonald, it’s become increasing focused on income generating smaller companies following its rebirth a little short of 3 years ago. I might add in passing that though I’m Northern Welsh by birth and both Southern English and Spanish by residence, down through the years I have developed something of a ‘soft spot’ for these Scottish fund managers.

Some relevant points about this trust:
· Given an initial 7-year life with a 30/04/09 wind-up date - being now a little over 48-month away.
· Currently approximately 70 holdings on its books with no single holding greater than 3% of total holdings. So able to get in and out of stocks without too much difficulty.
· Of late the manager’s been top-slicing and in some cases disposing of entire holdings into a rising market. Estimate there to be some £6-Million cash being held on deposit at the last count.
· Outstanding 7-year bank loan of £8.13 Millions on the balance sheet due to be paid back come wind-up. Get the impression that the Board of Directors are, at times, not entirely 100% comfortable with this amount of borrowing and have instructed the fund manager to take the opportunity afforded by recent price rises to run above average cash to reduce balance sheet gearing levels. I think they maybe reasoning that there is sufficient leverage now being applied (at a ratio of 1:1.6) for those shareholders seeking capital gain rather than income via the capital share structure of the trust.
· Pays a dividend twice a year presently totalling 4.65p – payouts have not been raised as yet during its current life.
· With a redemption price of 60p the income shares [SVLI] have been statically trading over par for sometime at a 3p spread of 62p – 65p.
· Income Shares are AAA2 rated and extremely well covered. Present portfolio valuations would need to drop by an average of 15% per annum before exposing the income share and 30% per annum before being ‘wiped out’ completely. Hence the reason for being highly rated by the market indicated by their over-par price

So assuming I can buy at 65p plus a bit extra to cover associated costs and stamp duty per income share before this coming June 16th. I should by approximately June 16th 2009 have received 9 dividend payments totalling 21.35p plus any forthcoming increases. That’s an initial annualised yield of 8% for the duration or to express it another way 6.7% net redemption yield per annum when allowing for a loss of 5p plus that little bit of purchase cost extra per share if redeemed at 60p. As an additional risk comparison the nearest 2009 UK Gilt Treasury stock is currently trading at net redemption yield of 4.5% per annum.

I did sometime ago look long and hard at several direct commercial property investment trusts that were being touted to income-interested investors looking to diversify somewhat away from equities. However, I gradually backed away after concluding such share prices were (and still are) at too big a premium to their difficult to value and possibly overpriced underlying illiquid property assets. Also, a good few of these Property Trusts’ debt levels secured against their physical assets were too much on the ‘scary’ side for my liking. Though, dividend yields appeared initially attractive I could see further increases down the line being possibly inhibited or even postponed should rental income increases not be forthcoming and / or voids become a recurring feature. For it is only from and out of such willingness of existing and future tenants to pay increased rents that higher than the average management charges are justified, borrowings are serviced and shareholders are allowed to get what’s left over.

All the best

forrado

As I lean back at arms length from my keyboard and think about what I’ve just written. I’ve quite enjoyed putting together this reply posting because for the purposes of my own game plan, it’s helped me rationalise and bring together a number of things into some kind order that were previously not so well defined in my own mind.