I like investment trusts as a basis for a passive income portfolio. They offer different strategies, so we can go for income without having to research individual stocks. And the usual wide-ranging nature of their holdings means we can get excellent diversification from a single investment.
My favourite is City of London Investment Trust (LSE: CTY). And I want to explain why it ticks my boxes.
Checkbox 1: dividend
The expected dividend yield’s a modest 4.4%, though that’s largely because the share price has done so well in the past five years.
It’s still a decent yield, based on the expected income from its top holdings. Those include HSBC Holdings (with a forecast 5.8% yield), Shell (4.3%) and British American Tobacco (7.1%).
Some holdings have low yields but have rewarded the trust with share price growth, like BAE Systems. On balance, this is a firm check for box 1.
Checkbox 2: cover
For individual stocks I like to see the dividend covered by earnings per share. That’s less meaningful for something like City of London, which gets its dividends from the earnings of the companies it holds.
But dividend cover among the FTSE 100‘s blue-chip stocks has been dependable, so that’s another checkbox ticked.
Checkbox 3: history
Managed by Janus Henderson, the trust has raised its dividend every year for the past 58 years. That puts it at the top of the Association of Investment Companies’ list of Dividend Heroes, which have managed the feat for at least 20 years in a row.
It’s the best record I’m aware of for UK dividend rises at such good yields. It’s the clearest possible pass on this one.
Checkbox 4: forecasts
Forecasts can’t make much sense in this case. The future depends on such a wide selection of UK stocks from different sectors that it would essentially be forecasting almost the entire market.
If I didn’t see a great long-term future for the UK stock market in general, I wouldn’t buy shares in anything. But I could see the next half-century being very similar to the last 50 years. It’s four out of four.
Checkbox 5: risk
My fifth check is usually on debt, as I rate that as one of the biggest dangers to long-term dividend prospects. I won’t buy shares in companies with huge debt, even if they offer bigger dividend yields than City of London.
The trust does gear up its investments with a small amount of debt to try to boost shareholders returns. But that gearing stood at just 7.6% at December 2024. It’s really not an issue.
The biggest general risk I see is the fear of not increasing the dividend one year. I reckon that could tank the share price. And being a company in its own right with its own management, it does offer more general risk than holding the same set of stocks individually. But the risk looks low enough to me to score it five out of five.
And that helps explain why I hold City of London Investment Trust.
