With inflation eating away at investors’ income, high-yield trusts can look very appealing. However, the big question investors should ask before committing themselves is just how sustainable are the dividend streams?

In this article we analyse four of the highest-yielding trusts, with a diverse mix of income generation, from European real estate and specialist lending to solar assets and Far Eastern stocks.

WINNING FORMULA

The highest-yielding trust on our screen, Schroder European REIT (SERE), invests in commercial property in a few select continental European cities in order to generate ‘a regular and attractive level of income return together with the potential for long-term income and capital growth’.

Its investments are focused on ‘winning cities’ such as Berlin, Paris and Seville which have higher than average levels of GDP, employment and population growth, attract higher-value companies, have a well-developed infrastructure and are attractive places to live and work.

The trust pays dividends once a quarter. It targets a dividend yield to investors of 5.5%, but earlier this month it paid a second interim dividend of 1.85 cents (1.56p) per share together with a special dividend of 4.75 cents (4p) per share.

Added to the 1.85 cents (1.56p) first interim dividend paid in April, this takes the yield to 7% on a 102p share price.

Assuming it pays two further interim dividends of 1.85 cents for the year to September, the prospective yield is 10%.

However, this year’s dividends may be an anomaly as the trust is using part of the €45 million proceeds from the forward-funded sale of a property in Paris last year to top up the regular dividend.

Investors will have to wait until the publication in December of the trust’s full-year results to know whether they are in with a chance of another special dividend next year to match this year’s exceptional payout. We think the current double-digit yield is unsustainable as it is dependent on exceptional property deals which can be irregular.

SECURED INCOME

Alternative finance firm VPC Specialty Lending (VSL) provides asset-backed lending solutions to emerging and established businesses with the goal of building long-term, sustainable income generation.

The £220 million company focuses on providing capital to what it calls ‘vital segments of the economy’, which for regulatory and structural reasons are underserved by the traditional banking industry.

Typical examples of funding include small business lending, working capital products, consumer finance and real estate, with the firm relying on its ‘rigorous due diligence and credit monitoring’ to generate stable income and ‘significant downside protection’.

The firm primarily lends against short-duration, cash-generating assets with predictable income, which in adverse circumstances can quickly be turned to cash to repay its investment.

It says it has found a ‘significant opportunity to earn attractive risk-adjusted returns through its extensive sourcing relationships around the globe, largely focusing on emerging sectors of the digital economy where pricing margins have not yet compressed but risk can be properly underwritten’.

The firm primarily lends to privately-owned US companies, although its top five investments – which make up 45% of its net asset value – include asset-backed loans to a Latin American group and a Singapore-based group.

As of the end of March, the weighted average coupon rate on the asset-backed lending portfolio, excluding gearing, was 10.42% and the weighted average term to maturity was 24 months.

Meanwhile, the firm paid a first quarterly interim dividend of 2p per share in July for the three months to March, and assuming it follows the same pattern as the recent past it will pay 8p per share for the whole year which equates to a yield of 10% based on a current 79.6p share price.

It is hard to say if the double-digit yield is sustainable – it might be if everything goes to plan, but there are plenty of examples of asset-backing lending not working out as expected.

EASTERN PROMISE

Henderson Far East Income (HFEL), which as of the end of June had £463 million of assets, describes itself as a ‘strong diversifier for income and growth-seeking investors’.

The trust uses a value-driven approach to invest both in companies with high and sustainable dividends and in companies with the potential to grow their dividends.

‘High dividends are for today, while rising dividends are for the future,’ says manager Mike Kerley, who has been at the helm since 2007.

Companies which are growing their dividends tend to get rerated over time, generating capital gains for the trust, adds Kerley.

The trust invests in developed and emerging Asian markets, with a strong focus on cash flow as a measure of both sustainability and profitability as it is cash flow which ultimately finances dividends.

Asia has the potential to increase payouts at a faster rate than other regions, argues Kerley, because dividend levels are currently low by international standards.

The sector allocation at the end of June was heavily skewed towards financial and telecoms companies, which have a combined weighting of over 40%, although technology and energy stocks also had a significant presence at 13% and 12% of the portfolio respectively.

The trust pays quarterly dividends, and this year has so far distributed a total of 17.8p across three interim payments.

While it hasn’t confirmed as much, the fourth interim dividend to be paid in November is likely to be 6p in line to maintain the trust’s long history of rising payouts.

That would equate to an annual yield of 8.7% based on a 275p share price, and while the discount to net asset value is towards the low end of its recent range, a yield of more than 8% looks very attractive. We think this level of dividend is sustainable.

BRIGHT FUTURE

With the sharp rise in fossil fuel prices this year and a resurgence of interest in renewable energy it is no surprise that solar funds, which had been out of favour for quite a while, have come good.

One of the largest UK-listed funds is NextEnergy Solar (NESF) which owns a portfolio of 100 solar assets – 92 in the UK and eight in Italy – with an installed capacity of 865 MW (megawatts).

Solar power is the most powerful and plentiful available, with more energy hitting Earth in a single hour than the entire global population uses in a year.

Moreover, thanks to a significant drop in the price of technology over the last decade it is also now one of the most cost-effective energy sources.

According to the NextEnergy Solar, the levelised cost of energy for solar has declined by 90% in the past 10 years making it the cost leader over other power technologies.

However, industry body Solar Energy says for the UK government to hit its net zero target by 2050 it will need to triple solar capacity by the end of this decade.

As the leading operator in terms of assets, that puts NextEnergy Solar in prime position to benefit from this expansion.

So far, for the year to March 2023, the firm has announced an interim dividend of 1.88p per share payable in September.

The target dividend for the full year is 7.52p, which at a price of 118.2p means the shares are trading on a 6.4% yield, well above the market average.

‘This will mark eight years of consecutive dividend increases from NextEnergy Solar,’ said James Carthew, co-founder of research group QuotedData, in April. ‘Since launch, it has paid out over £250 million in dividends. Each year, these have been covered by earnings and the statement says that the company is aiming to maintain that record.’

Unless solar prices plummet dramatically, we have confidence in NextEnergy’s dividend sustainability.

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