Whenever I see a dividend stock with a yield above 10%, I’m always somewhat nervous. A yield this high could spell trouble, for example if the share price has been falling fast.

However, there are some cases where a high yield is justified and sustainable. So when I eyed a company with an 11.32% yield, I thought it worth doing some more research.

Focused on European credit

I’m talking about the Chenavari Toro Income Fund (NASDAQ:TORO). The portfolio’s managed and focuses mainly on structured and leveraged credit. In simple terms, it invests in things such as collateralised loan obligations (CLOs), asset-backed securities and portfolios of bank loans. These can generate much higher yields than conventional government or corporate bonds, but investors are accepting considerably more risk in return.

The higher rates charged are one factor why the dividend yield‘s so high. For example, the fund actively targets a 9%-11% annual total return, including quarterly dividends. Given this is one of their objectives, sustainable dividends are therefore key to this.

However, another factor why the yield’s high right now is because the share price is down 16% in the past year. This acts to push up the yield, given it goes into the calculation.

I think there are two main issues for the share price underperformance. First, investors understandably demand a large risk premium for owning risky European credit at a point when economic uncertainty remains high.

Secondly, the dividend has been drifting down. Quarterly distributions have fallen from €0.018 per share in spring last year to €0.014 most recently. This is a reduction of more than 20%.

Direction from here

Based on the dividend information, I wouldn’t assume today’s yield’s guaranteed at all. However, a postive slant is that Toro operates a variable distribution policy, so payouts can move higher and lower easily depending on performance.

That’s actually healthier than stubbornly maintaining an unsustainable fixed dividend. Really, even after the recent reductions, shareholders are receiving a substantial amount of cash, while the fund’s target return is still their main focus.

Even with this optimism, I think things ultaimtely look too good to be true. Unlike a mature operating company with predictable free cash flow, Toro’s income ultimately depends on the performance of credit assets and debt markets, which aren’t predictalbe at all.

It’s not an area I’m well acquianted with either, and trying to invest in something I’m not comfortable with is never a good sign, even if the income looks juicy! On that basis, I think there are better stocks to consider elsewhere, including some with attractive high yields.

Investors who disagree with me could consider investing in this fund. After all, the high risk is compensated by a double-digit dividend yield.

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Jon Smith does not hold any positions in the companies mentioned.