Questor: bigger is better for these high yield income trusts seeking to tie the knot

Bigger doesn’t always mean better for investors, but the merger planned by two popular income trusts has much to recommend it to their loyal bands of private investors.

The boards of City Merchants High Yield and Invesco Enhanced Income, two bond funds that have featured in this column, this week announced plans to merge. Under the plans the two small trusts, housing just £196m and £131m of assets, would combine to form the Invesco Bond Income Plus fund.

The proposed deal makes sense to Questor. The trusts share the same manager, Rhys Davies, as well as similar portfolios, both focused on higher yielding bonds.

Combining the two won’t require a costly overhaul of the enlarged portfolio and would bring economies of scale, with both sets of shareholders enjoying a reduction in the ongoing charges they pay.

Fund group Invesco’s fee would fall to 0.65pc on the new trust, down from the 0.75pc it earns as manager of City Merchants and 0.76pc on Invesco Enhanced Income, contributing to ongoing charges of 0.98pc and 1.03pc respectively.

Shares in the enlarged trust should be easier to trade, by virtue of its size, which would help to reduce the difference between the higher price investors pay to buy shares, and the lower price they receive when selling them. This is a high 3.8pc on Invesco Enhanced Income shares, according to Numis, the stockbroker.

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A larger size could also attract bigger investors who may have shunned the trusts, potentially boosting the shares’ rating. Both City Merchants and Invesco Enhanced Income trade at discounts to their assets, but for long stretches before last year were at a premium.

Ewan Lovett-Turner, of Numis, is supportive of the deal. “It’s exactly the sort of transaction we’ve been calling for in recent years,” he said. “When you’ve got similar strategies, trying to make something of a size that can be on the radar of a wider group of investors has benefits for everyone involved.”

So far so good, for both sets of shareholders. The compromise between the two comes with the dividends they can expect from the larger trust.

It is on this front that the two trusts differ. Invesco Enhanced Income has a higher yield, of 6.8pc, compared to City Merchants’ 5.3pc, largely because the former borrows money to invest in more assets. City Merchants does this too, but to a much lesser degree: its “gearing” stands at 2.8pc of the trust’s assets, versus its stablemate’s 20.8pc.

The new trust will aim for a middle ground between the two approaches, with gearing of 10pc. For City Merchants investors, that should lead to an increase in dividend payments. The two boards are targeting an annual dividend of 11p from the new trust, up from City Merchants’ 10p.

Invesco Enhanced Income shareholders are set for a fall in their income, however.

With the assets of both trusts at their current level, they are set to receive two shares in the new trust for every five they currently hold. That means the 11p dividend would translate to 4.25p for each share they hold now, down from the 5p they have been receiving, although a one-off 0.75p payment has been proposed to keep the dividend level for the first year.

Some shareholders will see that as a blow, but it’s one they were likely to have faced even without the merger. Invesco Enhanced Income has been paying out more in dividends than it has generated from the coupons of the bonds it holds for a number of years, gradually chipping away at reserves. Its board also last year warned investors that it was reviewing the sustainability of its 5p annual payout given ultra-low interest rates in response to the pandemic.

We last reviewed our stance on the trusts in August after Mr Davies took on lead responsibility for the funds, following the departure of long-standing managers Paul Read and Paul Causer. So far, Mr Davies is delivering the continuity his appointment promised, having been involved in the management of the funds since 2014.

Private investors dominate the shareholder registers of both trusts and Questor recommends readers who own either to hang on to their shares and vote in favour of the merger. 

Questor says: hold

Ticker: CMHY, IPE

Share price: 190p, 73.8p

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