Kepler Trust Intelligence
Updated 21 Apr 2023
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Invesco Bond Income Plus. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Generating a reliable income has always been one of the foremost goals of investors. Younger investors tend to invest for capital growth but that starts to change as they get older.

Instead of wanting to generate large capital gains, they’re much more likely to want their investments to pay out so they can have cash to use during retirement.

Although generating income from your investments is a straightforward goal, there are lots of ways that investors go about trying to achieve it.

It might mean they focus their efforts on bonds, stocks, or alternative investments, like real estate or private debt. There’s also nothing to stop people from mixing things up and having holdings in a range of assets that they believe will generate income.

Investing in bonds for income

In the past, the bond market was typically seen as the go-to for income investors. As bonds are usually structured to pay out a fixed sum of cash at regular intervals and over a set period of time, they’re often regarded as offering a mix of reliability and, if they are issued by a reliable counterparty, low risk to income investors.

Bond investors have had a strange time since the financial crisis in the late 2000s. Many central banks set their interest rates close to zero in the wake of the crisis. This meant government bonds from countries like the US and UK, the traditional go-to for many investors, offered anaemic yields.

However, this started to change in late 2021. Central banks came under pressure to raise interest rates to try and stem the wave of inflation, which emerged in the wake of the Covid-19 pandemic. As a result, lower risk bonds, such as treasuries and gilts, are now offering more attractive yields than they have in over a decade.

This may mean we will see a shift back into these assets, after a long period in which they did not offer much to make them appealing for investors.

It’s also worth remembering that the bond market is much broader than those issued by a few governments in developed markets. Companies and governments across the world issue bonds and many of these yield comparatively high returns.

The problem is they do tend to carry more risk with them. Investors should take note of these risks prior to investing, given that the likelihood of default – and investment losses – are commensurately higher.

Investing in stocks for income

One consequence of the low yields in government bonds that we saw after the financial crisis was a move towards equity markets.

Equities have always been a source of income for investors, so that’s not to say this was new territory for them. But it did mean income investors had more exposure to stocks than they might have in the past.

Typically income investors put their cash into larger, blue-chip stocks. In the UK, that has usually meant firms like Unilever, HSBC, or Shell.

The reason for this is fairly straightforward. Large, established companies don’t tend to have ambitious, capital-intensive growth plans, meaning they’re less likely to reinvest their earnings and can pay dividends instead.

For those investors looking for the level of reliability that government bonds provided in the past, larger businesses are also perceived as offering a measure of stability. Rightly or wrongly, investors tend to believe these companies will be around for a while, earning stable revenues and paying out predictable dividends.

This is, of course, just a rule of thumb and there are still large companies that don’t pay dividends and smaller ones that do. But income investors do usually like stability and predictability, something that we tend to see as a feature of larger firms.

Income investing using alternative investments

Alternative investments is a broad term that could refer to anything from fine art collections to a hedge fund.

For private investors it usually means investing in things like real estate, debt products, or commodities.

Obviously not all of these are easily accessible, nor do they all provide a source of income – a gold bar remains a gold bar, no matter how long you hold it for, so you aren’t going to get any dividends from it.

Probably the most popular alternative investment option for regular investors is real estate. A house or flat can generate rental income that’s reasonably reliable and predictable. It’s also more readily accessible to a regular investor compared to a large-scale private equity investment.

Still, buying a home for investment purposes is likely to be out of reach for many people. That’s why regular investors, looking for income, may invest in a fund that holds alternative assets instead.

Doing so is cheaper and simpler than attempting to go it alone. For instance, if you want to invest in commercial real estate you’ll need a huge amount of money. Investing in a fund that pools together a large amount of money and then invests in commercial real estate is a much more realistic option for most people.

Using investment trusts for income

This is one reason that investment trusts appeal to income investors. Income-producing alternative assets are much more easily accessible through a trust than they would be if an investor wanted to do it alone.

And the various trusts listed in the UK offer a broad range of alternative assets to investors. For instance, TwentyFour Income (TFIF) tries to generate income by investing in asset-backed debt securities. Alternatively, Greencoat Capital operates two investment trusts that attempt to generate income from investments in renewable energy infrastructure.

Beyond these more niche investments, trusts can also generate income from investing in traditional asset classes, like bonds and equities.

Some investors may choose trusts that invest in these because they’re focused on markets that are hard to access for retail investors. For instance, regular investors may find it almost impossible to purchase shares in some East Asian countries themselves. Similarly, buying certain corporate or government bonds can be difficult to do alone.

But this obviously isn’t true across the board. UK stocks are, for instance, pretty easy for regular investors to access themselves, so why bother with a trust?

One reason is they offer access to professional portfolio managers. Stock picking isn’t a simple task and many people find it more convenient to hand the reins over to someone else.

This is particularly the case if you have a specific goal in mind, like generating income, and don’t want to take on the risk of managing it yourself. Anyone considering this should keep in mind that trust’s that have a particular style or purpose often have a lot of overlap, in terms of the assets they hold, so it’s worth checking that you’re not doubling up by buying shares in several trusts.

Trusts also tend to have diversified portfolios and thus offer investors the ability to access a mix of assets through one investment. This may be particularly appealing if an investor has a specific goal in mind, as the trust can act as something of a ‘one stop shop’ for them. Rather than having to pick a whole basket of assets themselves to meet that goal, they can just buy one share in the trust.

How investment trusts can help income investors

Aside from the actual investment process, trusts have unique structural benefits which make them particularly suitable for income focused investors.

Trusts are legally required to pay out 85% of the dividends they receive. For real estate investment trusts the figure is 90%.

The remaining 15% or 10% can be kept in reserve and used to smooth out payments during rough patches in the market. Open-ended investment companies must pay out all of their income, meaning they don’t have this benefit.

The benefit of being able to keep income in reserve was on display during the Covid-19 pandemic in 2020. Whereas many firms were forced to slash dividends or cut them entirely, close to 90% of investment trusts maintained or increased their payouts.

That was possible in large part because of the reserves that many trusts have built up over the years. For income investors, many of whom are partial to that mix of stability and predictability, this ability to retain dividends is thus a very attractive feature.

Income from capital

Another benefit that trusts have for income investors, which complements the above, is the ability to pay dividends from their capital reserves. In simpler terms, this means they can pay a dividend to their shareholders by converting some of the capital growth generated by their investments into an income.

Generally income paid from capital reserves is undertaken in line with a specific dividend policy. This will usually be an agreement by the trust to pay out dividends as a percentage of the trust’s net asset value (NAV).

This may be done once a year or more frequently. For example, Invesco Perpetual UK Smaller Companies (IPU) has a policy of paying out a dividend that’s equal to 4% of its NAV at the year end. JPMorgan Japan Small Cap Growth & Income (JSGI) takes a different approach by paying out 1% of NAV at the end of each quarter. And International Biotechnology (IBT) pays a dividend equal to 4% of NAV at the end of its financial year, but in two instalments, one in January and the other in August.

Trusts can mix and match in meeting these commitments. For instance, half the payout may come from dividends generated by the trust’s holdings, whereas the other half may come from capital reserves.

It’s worth keeping in mind that paying out of capital reserves carries some risk with it. Selling off assets to meet dividend requirements can depress a trust’s NAV, something that can make a bad situation worse if a trust has had a period of poor performance.

That may not please income investors but then they’ve still got plenty of options open to them. And in the long-run, they’d likely be better off choosing an income-focused trust, rather than one that’s decided to adopt a dividend policy which may not be best-suited to its investment strategy.

Why a closed pool of capital helps investment trusts

The investment trust structure is also key to their being able to invest in more niche areas of the market that can produce income.

A closed pool of capital means the buying and selling of trust shares doesn’t impact a trust’s underlying portfolio. This means that trusts are freer than open-ended funds, which must contend with redemptions, to invest in more illiquid assets.

As discussed above, this might include areas like renewable energy infrastructure or commercial property. But there are more specialized areas too.

For instance, Hipgnosis Songs (SONG) invests in music rights. It receives income from anyone licensing its back catalogue, whether it be someone streaming the song on Spotify or using it as part of a film’s soundtrack.

Accessing these sorts of funds outside of the investment trust market is tricky and trusts’ structure is a key reason for that.

Case study: Invesco Bond Income Plus (BIPS)

Company: Invesco Fund Managers Limited

Launched: Formed in 2021 through the merger of Invesco Enhanced Income and City Merchants High Yield Limited

Manager: Rhys Davies and Edward Craven

Ongoing charges: 0.86% including annual management fee (as at 31/01/2023, Source: Invesco factsheet)

Dividend policy: Target annual dividend of 11.5p per share. This is a target and there is no guarantee the dividend will be paid

Benchmark: The company does not have a benchmark

One investment company that aims to provide income to investors is Invesco Bond Income Plus (BIPS). BIPS invests primarily in high-yielding fixed-interest securities, with the goal of providing a mix of capital growth and income to shareholders.

The company was formed through the merger of the Invesco Enhanced Income and City Merchants High Yield Limited in 2021. BIPS continued to pay a dividend during the pandemic and, once the merger was complete, the company’s management team confirmed it would target an 11p per share annual dividend for the following three years. In the third quarter of 2022 the board decided to increase this target to 11.5p per share per year, paid quarterly.

The BIPS portfolio is made up of typically higher-yielding corporate bonds and financial debt instruments. BIPS also holds a small number of bonds that have come under price pressure but where the portfolio managers believe the companies are capable of turning around their businesses.

Risk is obviously a major consideration in the high yield bond market and BIPS portfolio managers Rhys Davies and Edward Craven try to mitigate this using their skill, experience, and judgement to diversify the portfolio. It’s not uncommon for the portfolio to hold over 100 companies, meaning a single bond issuer defaulting will not by itself lead to a large loss of NAV.

High yield bonds of the sort held by BIPS are typically harder for retail investors to evaluate and invest in by themselves. Anyone looking to gain some exposure to the corporate bond market may want to consider doing so via an investment company like BIPS as a result.

1. What is the company’s goal?

Invesco Bond Income Plus aims to produce capital gains and income for investors by investing in a diverse portfolio of high yield bonds and other fixed interest securities.

2. What kind of bonds do the managers like?

Portfolio managers Rhys Davies and Edward Craven, supported by their team, typically invest in a diversified portfolio of bonds issued by large and medium-sized businesses across the sectors of the economy, both corporates and financials. They are also happy, to a limited degree, to invest in bonds which have experienced substantial price pressure but only if they believe there is a strong enough case for a turnaround.

3. Are investment decisions driven by a particular investment style?

Fixed income brings with it credit risk and the possibility that issuers will default, more so in high yield bonds. Reducing the likelihood this will happen is a big part of the decision-making process at BIPS as a result. The company aims to hold bonds issued by companies the team know well, where they have confidence in their ability to service their debt. It also means holding a diversified portfolio of bonds, to potentially reduce any downside risk.

4. How many bonds does the company typically hold?

In line with those efforts to offer sufficient diversification, the company typically holds a diversified portfolio of around 200 individual fixed income securities. This number is not fixed and can change.

5. What is the company’s dividend policy?

After BIPS was formed from the merger of Invesco Enhanced Income and City Merchants High Yield Limited , management said it would target an 11p per share dividend for the following three years. In the third quarter of 2022, the board decided to increase the target dividend to 11.5p per share per year. Assuming it meets that target, the dividend will be paid out via four 2.875p per share dividends, issued on a quarterly basis. The company typically pays dividends from income it receives but may use capital and revenue reserves to pay shareholders if it experiences a shortfall. Please note as dividend policies and future dividend payments are determined by the board, they are not guaranteed.

6. What are the company’s ongoing charges?

The company’s ongoing charges are 0.86% at the time of publication, with an annual management fee of 0.65%. Note that this can change over time.

7. Does the company have performance fees?

The company does not have performance fees. The portfolio managers are invested in the company, so their interests are aligned to shareholders.

8. How much attention do the portfolio managers pay to their benchmark, and to what extent are absolute returns important?

Unlike most investment trusts, BIPS does not run against a benchmark, nor do the positions it takes reflect one. The portfolio managers do look at the BofA Merrill Lynch European Currency High Yield Index as a way of gauging their performance but the index is also not reflective of the positions BIPS takes. Rather than obsessing over their performance relative to a benchmark, the BIPS team are focused on achieving the company’s stated goals – delivering a high level of income and capital growth to shareholders.

9. Does the company use gearing and if so is it structural or opportunity led?

The company uses gearing, when appropriate, to potentially enhance the income it generates. Levels of gearing tend to fluctuate as a result. The company uses gearing by means of repo financing.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When making an investment in an investment trust/company you are buying shares in a company that is listed on a stock exchange. The price of the shares will be determined by supply and demand. Consequently, the share price of an investment trust/company may be higher or lower than the underlying net asset value of the investments in its portfolio and there can be no certainty that there will be liquidity in the shares.

Invesco Bond Income Plus has a significant proportion of high-yielding bonds, which are of lower credit quality and may result in large fluctuations in the NAV of the product.

The product uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.

The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall.

The product may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.

Important Information

For more information on Invesco Bond Income Plus Limited, please refer to the relevant Key Information Document (KID), Alternative Investment Fund Managers Directive document (AIFMD), and the latest Annual or Half-Yearly Financial Reports. Further details of the Company’s Investment Policy and Risk and Investment Limits can be found in the Report of the Directors contained within the Company’s Annual Financial Report.

Invesco Fund Managers Limited. Invesco Bond Income Plus Limited is regulated by the Jersey Financial Services Commission.

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