In this current environment of low interest rates it's very hard to find a good source of attractive income except for shares.
Bank interest rates are woeful and term deposits are little better. Residential properties probably offer negative cash returns with the current low gross yields. Bonds and commercial property also don't look like good ideas with US interest rates rising.
I think the only source of income that's worth looking at is shares, particularly once you add on franking credits.
One of the best sources of income in my opinion is Naos Emerging Opportunities Company Ltd (ASX: NCC), a listed investment company (LIC) run by Naos Asset Management. This is the LIC that has been in the Naos stable the longest and focuses on shares that have market capitalisations under $250 million.
The LIC currently has a grossed-up dividend yield of 8.5%. However, it's not just the size of the dividend that makes it attractive:
Outperformance
Since inception that Naos Emerging Opportunities portfolio has returned an average of 15.39% per annum after expenses, but before fees. This performance has beaten the S&P/ASX Small Ordinaries Accumulation Index by 8.69% per annum. Small caps give the best chance of creating strong performance.
If Naos can continue this level of outperformance over the long-term then the dividend can continue to grow at an attractive pace, whilst the capital value of the shares will also grow nicely as well over time.
Growth of the dividend
One of this LIC's main aims is to pay a growing fully franked dividend to shareholders. It has been very successful in this regard – the dividend has grown each year since it started paying a dividend in the second half of FY13.
I imagine it will be able to keep growing the dividend in most scenarios considering it already has a decent profit reserve. The main risk to the dividend would be a recession, which usually hurts small caps more than most.
Value
Whilst some LICs out there are trading at significant premiums to their net tangible assets (NTA) per share, Naos is trading at close to its NTA, which means it looks better value on a conventional valuation. It also means that the yield is higher than if the LIC were trading a significant premium to the NTA.
Foolish takeaway
I'd be happy to buy some shares at today's price and add more shares if it traded at a decent discount to the NTA in the future or if the small cap section of the market was sold off.
