3 investment trust ideas that could help tackle inflation

An investment trust is a type of fund set up as a company, so its shares can be bought and sold on the stock exchange. They aim to make money for their shareholders by investing in a portfolio of shares, property or other assets, chosen and run by the investment manager. When you buy a share, you’re buying a slice of the trust’s underlying portfolio.

The price of an investment trust can differ from the net asset value (NAV) by trading at a premium or a discount. The premium or discount is determined by supply and demand.

If the current share price is above the NAV, the investment trust is said to be trading at a premium. That means it costs more to buy the shares than the underlying investments are worth. When the share price is below the NAV, it’s trading at a discount.

This article isn’t personal advice. If you’re not sure an investment or course of action is right for you, ask for financial advice. All investments and any income they produce can rise and fall in value.

Why are investment trusts different when it comes to income?

Investment trusts have more flexibility to smooth out the ups and downs of the stock market and help maintain a rising and sustainable income.

They can hold back up to 15% of their income when times are good, effectively creating a rainy-day pot known as the ‘revenue reserve’.

If the dividends paid by the trust’s investments fall one year, the manager can dip into the reserve to make up any shortfall. So, the trust can top up dividends in the bad years and smooth out the dividends their investors receive over time. However, frequently dipping into reserves to increase the income pay-out is unlikely to be sustainable in the long term.

Some trusts have used their revenue reserves well in recent years amid the disruption caused by Covid-19. The speed and scale of the coronavirus crisis had an immediate impact on dividends. Some of the natural hunting grounds for income, like banks and oil, were hit hard as the pandemic reduced demand for travel and caused significant economic slowdowns.

Trusts that have managed to increase their dividends for 20 plus consecutive years are known as ‘dividend heroes’. There are currently 17 investment trusts that have achieved ‘dividend hero’ status. Some of these trusts have used their revenue reserves to great effect to smooth the income received by investors.

Remember though, past performance isn’t a guide to the future and dividend income is variable and not guaranteed.

Trusts aren’t limited to paying out a dividend just from the income they receive from their underlying investments. They can also use the profits they make from buying and selling investments. However, this could erode a trust's potential for growth in the future.

Trusts can also use 'gearing'. This lets them borrow money to invest in more dividend-paying shares. It has the potential to boost both income and growth. The extra return might not cover the cost of gearing though, and it could also increase losses when share prices fall, so it's a higher-risk approach.

Investment trusts with a history of income growth can play a useful part in a portfolio, especially with savings rates still so low and inflation rising. Any income paid out can help to soften the blow of the rising cost of living. Remember though, unlike the security offered by cash, investing does come with the risk that you could get back less than you invest.

Even if you don’t need the income now, investors always have the option of using the proceeds to buy extra shares in the trust. Over the long term, this can be a great way to grow capital, though there are no guarantees.

Investment trusts can sometimes invest in specialist areas like smaller companies, derivatives, and unlisted (private) companies which are higher risk. Investors should only invest in them if they have the time and knowledge to carefully select and monitor them, and as always, they should be held as part of a diversified portfolio.

3 investment trust ideas

Please note that the past performance mentioned in the investment trusts below aren’t a guide to the future.

City of London Investment Trust

Long-serving manager (since 1991) Job Curtis invests in good-quality, well-managed companies, which can be bought at reasonable share prices.

He likes larger, more stable companies which often have multinational operations that are robust enough to weather economic storms and still pay dividends. Curtis also takes advantage of the trust’s ability to invest up to 20% of its assets overseas.

Curtis is part of a large and experienced team of income investors at Janus Henderson and is focused on providing long-term growth in income and capital.

In the trust’s last financial year to the end of June 2021, it used revenue reserves built up in previous years to contribute to the dividend, which rose 0.5%. This helped extend the trust’s record as the investment company that has consistently increased its dividend for the longest period – now standing at 56 years.

At the time of writing, the trust trades on a 2.30% premium to the NAV and yields 4.76%. Remember though, income isn’t guaranteed, and yields aren’t a reliable indicator of future income.

More about City of London Investment Trust, including charges

City of London Investment Trust Key Information Document

Merchants Trust

Manager Simon Gergel mainly invests in larger companies listed in the UK with the aim of providing a high level of income. He also looks for a growing income and capital return over the long term.

Gergel’s investment process focuses on three key areas. He aims to understand the fundamentals of a company, including its competitive position and financial strength. He also assesses valuations compared with both the company’s own history and its peers. Finally, he considers industrial and consumer themes along with the wider outlook for the economy. The fund invests a small amount in smaller companies which adds risk.

The trust increased its dividend by 0.4% in the year to the end of January 2022, again using reserves accumulated during the good times to boost the income paid to investors. This is the 40th consecutive year the trust has increased the dividends it’s paid to investors – the 12th longest record of any investment trust.

At the time of writing, the trust trades on a 1.48% premium to NAV and yields 4.84%. Remember though, income isn’t guaranteed, and yields aren’t a reliable indicator of future income.

More about Merchants Trust, including charges

Merchants Trust Key Information Document

Murray International Trust

Abrdn’s Bruce Stout has been lead manager of the trust since 2004. Stout aims to grow income and capital over the long term by investing in companies from around the globe, as well as holding some bonds.

The trust invests more in higher-risk emerging markets compared with some peers. The region it has the most invested in is Asia Pacific (excluding Japan).

Stout and his team invest in high-quality, financially robust companies that have the potential to grow earnings and dividends over the long term. There’s an emphasis on resilient business models, a unique set of advantages over the competition and experienced management teams.

The trust increased its dividend by 0.9% in the year to the end of December 2021, again using reserves accumulated during the good times to boost the income paid to investors. This is the 17th consecutive year the trust has increased the dividends it’s paid to investors.

At the time of writing, the trust trades on a 3% discount to NAV and yields 4.46%. Income isn’t guaranteed though, and yields aren’t a reliable indicator of future income.

More about Murray International Trust, including charges

Murray International Trust Key Information Document

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