Alliance Trust’s dividend pledge is backed up by its strong reserves

This ‘dividend hero’ is in a strong position to keep hiking payouts. Kyle Caldwell explains why.

Alliance Trust (LSE:ATST) is the latest investment trust ‘dividend hero’ to announce a rise in income payouts for shareholders. Dividends were increased by 3% to 14.38p (for the year to 31 December 2020) despite the challenging backdrop for generating income.

Owing to the Covid-19 pandemic, UK dividends declined by two-fifths in 2020. This marked the worst period for payouts since the Second World War, according to the UK Dividend Monitor report from Link Group.

Global dividend declines were less serve than in UK, at 12%. However, this was a significant headwind for funds and investment trusts that return income to investors as part of their mandate.

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Alliance Trust, which through a multi-manager structure invests globally, was, like other funds and trusts that generate income, negatively impacted. In its annual financial report published yesterday, it acknowledged that there was a “reduced level of income this year due to investee companies cutting the level of their dividends, or not paying dividends at all. The company used £10 million of its revenue reserves to meet the cost of the dividend in 2020.”

The trust’s remaining dividend reserves stand at £99.2 million. The report notes that even in the extremely unlikely event of no income being generated by the underlying holdings for the next two years, the trust could continue to pay an increasing dividend from its revenue reserves alone.

In a move to further strengthen the dividend, Alliance Trust intends to ask shareholders at its Annual General Meeting (AGM) for approval to convert its merger reserve of £645.3 million into a further distributable reserve.

Alliance Trust added in its annual report that it “expects that it will continue to extend its record of year-on-year increases in dividends”.

Craig Baker of Willis Towers Watson, head of Alliance Trust’s investment committee, notes that if the merger reserve gains approval, the trust would, in theory, be able to raise dividends for the next 75 years if it had a £10 million shortfall each year.

“No one is worried about the trust’s progressive dividend policy. We are in a strong position as we have significant reserves,” he told interactive investor.

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In terms of total return performance, 2020 saw Alliance Trust underperform its benchmark – the MSCI All Country World Index. Alliance Trust’s share price increased by 9.4% and its net asset value (NAV) return stood at 8.5%. In contrast, the benchmark returned 12.7%.

Baker said the underperformance was not a surprise given that the index’s performance was heavily skewed towards five of the US technology giants – Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL). He notes that the five companies contributed 45% of the MSCI All Country World Index’s return in 2020.

Baker expects share price performance to broaden across countries and industries as the global economic recovery gains momentum. In turn, he expects this to benefit Alliance Trust, which employs nine fund managers to run a “best ideas portfolio” of typically 20 stocks.

“Our performance is not predicated on how the US tech giants perform, but a broader number of companies outperforming going forwards should be something we will benefit from,” he says.

Overall, since Willis Tower Watson took over the management of Alliance Trust in April 2017, its share price total return is 41% versus 41.4% for its benchmark.

Why trusts have income edge over funds

Investment trusts can hold back up to 15% of dividends received each year, which means they can build up a reserve to bolster payouts in leaner years. In contrast, funds have to distribute all the income generated by the fund. Therefore, when income dries up, as it has done in 2020, a dividend cut looks inevitable for funds.

A total of 11 trusts have raised dividends for 40 years or more, and all have pledged, or are on track, to keep those records going. If the dividend drought continues for a prolonged period of time, boards will have tough decisions to make, but in the short term the ‘rainy day’ reserves are being used to weather the dividend storm.