Bill Jamieson: Take care not to be captured by Triffid Yields

Triffid Yields are back '“ an invasive species comprising abnormally high dividend yields on some of the market's leading shares and investment trusts that could lure unsuspecting investors and wreck income portfolios.

This species – named after the creatures in the sci-fi classic The Day of the Triffids – comprise shares sporting abnormally high dividend yields. As share prices fall, the prospective dividend income rises in tandem. They made a spectacular appearance in the global financial crash of 2008-09. As share prices plunged, dividend yields soared – giving the impression that huge income bargains were to be had.

Outstanding triffid yields were to be found across the financial sector – banks in particular. But these sky-high yields, far from being an indicator of value, were a high alert warning of deep trouble, and that dividend payments were soon to be cut or passed altogether.

Now, with the sharp falls in the stock market, Triffid Yields are back.

Investors have already suffered. Last year saw dividend cuts from Morrisons, Standard Chartered and Severn Trent. By the end of the year, mining giants Glencore and Anglo American had suspended dividend payments completely. Stockbroker Winterflood reckons total dividends across the FTSE All-Share in 2015 fell by 11.5 per cent, the first fall since 2009. Further cuts are now widely predicted.

But the “Triffid Hunt” is not as simple as spotting high numbers in the dividend yield column. Prospective company earnings need to be weighed, the level of dividend cover examined – ie, the number of times the dividend pay-out is covered by earnings – and company statements on dividend policy read closely.

For the oil giants, the profits outlook is dire. BP is set to reveal annual results this week with analysts braced for a 66 per cent slump in the fourth quarter. Shell, due to report on Thursday, is set to reveal a fourth-quarter profits slump of around 57 per cent. As for dividend cover, Royal Dutch Shell and Rio Tinto are hovering at 1.0, BP at 0.9, and Aberdeen Asset Management at 1.2. GlaxoSmithKline’s dividend is barely covered. Russ Mould, investment director at AJ Bell, says only two of the top ten fattest yields in the FTSE 100 have a dividend cover over two times earnings.

So how safe are those income-orientated investment trusts? Funds adviser Stifel calculates that only five of the 21 highest-yielding trusts were trading at a premium to net asset value and all boasted yields of between 4 per cent and 12.5 per cent.

Among the highest yielders are BlackRock Commodities Income Trust (yielding 14.25 per cent) and BlackRock World Mining (12.4 per cent), whose shares tumbled 37 per cent last year. Other high-yielders and poor performers include Aberdeen Latin American Income (7.2 per cent), and Henderson Far East Income (7.1 per cent).

The portfolios of these trusts are heavily exposed to companies facing dividend cuts. But investment trusts overall have two latent strengths. Unlike unit trusts they can hold back revenues of up to 15 per cent to help them cope with stormy weather ahead. And since 2012 investment trusts are also able to pay income out of capital, although this is unusual.

According to the Association of Investment Companies, 11 investment trusts in the UK equity income sector have delivered a progressive dividend increase for more than ten years, against just two open-ended funds, and at least ten investment trusts have increased pay-outs for at least 40 consecutive years. But some trusts are better covered than others.

Trusts with lower cover include Merchants Trust with cover of less than one, meaning its earnings in 2014-15 did not fully cover its dividend payout. Merchants has increased its dividend for 33 consecutive years, but could struggle to retain such a high level of payout.

Revenue reserves are also important. Ewan Lovett-Turner, director of investment companies research at Numis, says: “You want a combination of revenue reserve and dividend cover. At the moment, across the UK Equity Income sector dividends are typically between 1 and 1.2 times covered and revenue reserves are an average of more than half the year’s dividends and I think that gives a good level of comfort.”

However, according to Numis, a large number of the trusts listed have less than half the previous year’s dividends held in reserve. Many hold less than 0.3 – bumping up against just a quarter of the year’s dividends.

Low dividend cover or low reserve cover on their own are not necessarily a bad sign, but low cover on both could be a concern. So, before being lured by Triffid Yields, do some checks.