Browse income funds in the specialist debt sector and you will find two investment trusts run by TwentyFour Asset Management, a fixed income specialist owned by the Swiss asset management group Vontobel that looks after £24 billion in assets under management.

TwentyFour specialises in asset-backed securities (ABS), so it is not surprising that the £1 billion does exactly that. It invests in a diversified portfolio of securities, each of whose income comes from a pool of underlying assets (such as corporate loans and mortgages). The underlying assets are floating-rate – ie, payments vary with changes in interest rates. About 15% are investment grade, 52% sub-investment grade and 33% unrated.

TwentyFour Income Fund targeted a return of 6%-9% per year on the original 100p issue price, including a minimum annual dividend of 8p, paid quarterly. Its net asset value (NAV) total return has averaged just under 8% per year since inception in 2013.

Income funds taking advantage of premium yields

By contrast, TFIF's smaller stablemate TwentyFour Select Monthly Income Fund – worth £300 million – invests in a broader range of debt, with the aim of taking advantage of the “premium yields available in less liquid securities across the global credit markets”. That means Additional Tier 1 (AT1) capital securities issued by banks, payment-in-kind notes (often issued as part of private-equity transactions), and leveraged loans, as well as ABS and corporate bonds.

At the end of September, just under 40% of the portfolio was invested in AT1 securities, with about a third in ABS and 15% in securities issued by insurers. Roughly a third of the portfolio is rated BBB (the lowest investment grade rating), while most is sub-investment grade and 7% is unrated.

In some cases, the rating is more of a function of where the securities owned by the trust sit in a bank's capital structure than the borrower's quality. AT1 capital notes are specifically designed to absorb losses in the event of a bank failure and are generally graded three to five notches below each bank's senior capital.

Hence SMIF's second largest holding is Nationwide's 10.25% Core Capital Deferred Shares, which are similar to the AT1 debt issued by banks (building societies have different rules for what they can issue). Fitch Ratings puts Nationwide as a group at A (five notches away from its highest AAA rating), but has a BBB- rating on its AT1 capital (just above sub-investment grade).

Rising rates

SMIF targeted a higher return of 8%-10% per year on the 100p issue price, comprising a 6p per share annual dividend paid in monthly instalments and a capital return of 2p to 4p. While the trust has consistently met its annual dividend target, capital growth has remained elusive. It has delivered a NAV total return of 6.4% per year since 2014, mostly from income. SMIF's performance has been weighed down by exposure to longer-duration securities, which underperform when rates rise. The Nationwide holding illustrates this. These securities, which mature in 2049, are very sensitive to interest rates. They have fallen about 10% in 2026 as interest rate expectations have risen. Since the beginning of 2022, the face value of the securities has fallen 35%.

More than half of SMIF's portfolio matures in five years or more. It has an interest rate duration of 3.5, implying the portfolio would fall by 3.5% if rates rise by 1%. Conversely TFIF holds floating-rate debt, so benefits from higher rates.

SMIF pays out 0.5p per month, plus a top-up at the end of its fiscal year in October. This year, a final payout of 0.912p brings the total to 6.66p per share, or 8.4% on the current share price, which looks tempting . However, with rates set to stay high and TFIF's portfolio generating an underlying yield of over 10%, it may remain the better choice.

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