Two alternative income funds

These two specialist debt funds sit in the same category, yet they give yield-seeking investors distinctly different choices.

A search of specialist debt income funds turns up two investment trusts managed by TwentyFour Asset Management. The fixed-income firm is owned by Swiss asset manager Vontobel and oversees 24 billion in assets.

TwentyFour focuses on asset-backed securities (ABS), and the 1 billion TwentyFour Income Fund (LSE: TFIF) follows that same approach. Its portfolio holds a broad mix of securities whose income comes from pools of assets, including corporate loans and mortgages. The underlying assets carry floating rates, so payments change as interest rates move. Around 15% are investment grade, 52% sub-investment grade and 33% unrated.

TwentyFour Income Fund aimed to deliver an annual return of 6%-9% on the original 100p issue price, with at least 8p paid in dividends each year across quarterly distributions. Since its launch in 2013, the fund's net asset value (NAV) total return has averaged just under 8% annually.

Sometimes the rating reflects the securities' place in the bank's capital structure more than the borrower's credit quality. AT1 capital notes are built to absorb losses if a bank fails, so they typically rank three to five notches below that bank's senior capital.

SMIF's second-largest holding is Nationwide's 10.25% Core Capital Deferred Shares. They resemble the AT1 debt banks issue, although building societies face different rules governing their securities. Fitch Ratings assigns Nationwide as a group an A rating - five notches below the top AAA grade - while its AT1 capital carries a BBB- rating, just above sub-investment grade.

Rising rates

SMIF aimed to return 8%-10% a year on its 100p issue price: shareholders received a 6p annual dividend, paid in monthly instalments, while capital growth was expected to add 2p to 4p. The trust has met its dividend target consistently, but the hoped-for capital growth has not materialised. Since 2014, it has produced an annualised NAV total return of 6.4%, with most of that return coming from income. Longer-duration securities have hurt performance because they tend to fall when interest rates rise. The Nationwide holding shows the problem clearly. Its securities mature in 2049, making them particularly sensitive to rate expectations; they fell about 10% in 2026 as those expectations increased. Since the beginning of 2022, their face value has dropped 35%.

Over half of SMIF's portfolio comes due in five years or longer. Its interest-rate duration is 3.5, meaning a 1% rise in rates would reduce the portfolio's value by 3.5%. TFIF is different: its floating-rate debt gains value when rates increase.

SMIF pays 0.5p each month, then adds a top-up when its financial year ends in October. The latest 0.912p payment takes the annual total to 6.66p per share - an 8.4% yield at the current share price, which looks tempting. Even so, interest rates may stay high, and TFIF's portfolio earns an underlying yield above 10%, so it could still be the stronger option.