Dividend hero City of London’s stock picking beats the market

City of London Investment Trust, a favourite among income investors, has delivered another year of rising income payouts, stretching its track record of increasing dividends year in, year out, to 58 years.

Below is an examination of the results, including key performance drivers, as well as our ii view, which explains why we are fans of the investment trust, and why it appears on our Super 60 list of investment ideas.

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As well as reading the results, you may like to watch a recent video interview with City of London manager Job Curtis and Kyle Caldwell, ii’s funds and investment education editor.

• Watch our video: Why City of London has boosted banks to 20-year high
• Watch our video: Job Curtis: why I sold Microsoft, and a sector to watch

The numbers in detail (for financial year to 30 June 2024)

NAV (Net Asset Value) Return: +15.6%
Share Price Return: +11.3%
Benchmark Return (FTSE All-Share): +13%
Dividend: 20.6p(vs 20.1p prior year)
Premium/Discount: -2.2%(vs 1.5% prior year)
Gearing: 7.1%(vs 6.2% prior year)

Performance

Throughout the year, City of London Ord (LSE:CTY) produced a NAV return of 15.6%, outstripping the FTSE All-Share’s return of 13% and the peer group return of 12.6%.

However, the share price return of 11.3% marginally underperformed, due to the emergence of a small discount to NAV for the shares.

The portfolio’s strong performance came from holdings in private equity firm 3i Group Ord (LSE:III) – an investor in Action, the fast-growing discount retailer.

Top holding BAE Systems (LSE:BA.) – a manufacturer of defence equipment – also drove performance due to seeing heightened demand given the world’s geopolitical threats.

Unsurprising given the lowly level of UK valuations, takeover bids for portfolio companies Wincanton and Roundhill Music also boosted returns.

Outlook

Despite geopolitical and inflationary concerns, the beginnings of an improvement in the relative performance of UK equities versus overseas equivalents is notable.

The UK market remains much cheaper than global markets, which presents opportunity in the form of a likely continuation of corporate activity.

In addition, the yield from UK equities will become increasingly attractive as fixed-income yields recede when interest rates are cut.

Portfolio

The most notable change made to the portfolio was a reduction in the amount invested in overseas shares.

City of London is permitted a 20% allowance in companies listed overseas. Given that UK businesses typically carry lower valuations than overseas stocks, this was reduced from 15% to 10%.

The trust retains the overweight to financials, and the sector allocation (the largest sector of the portfolio) has grown from 26.3% to 29.3% throughout the period.

Long-standing fund manager Job Curtis is bullish on UK banks, adding to the position in NatWest Group (LSE:NWG), while also adding to insurer Aviva (LSE:AV.).

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The trust retains its diversified profile. Additions and sales were made on a stock-by-stock basis across the rest of the portfolio.

Gearing

The gearing level for the year was 7.1%, marginally increased on the prior year, and being positive to returns for the reported period. While borrowing costs for many have risen since 2022, City had the foresight to establish low-cost debt facilities for the next few decades before interest rates rose.

Dividend

The dividend of 20.6p per share represents growth of near 2.5% on the prior year and therefore a 58th consecutive year of dividend growth. The dividend growth is backed by an even greater growth in earnings per share and a substantial reserve amount remains.

ii View

In a context of a rising UK equity market, the trust’s performance in NAV terms was strong over the year, rising 15.6%, besting the FTSE All-Share’s 13% return.

Companies held by the portfolio performed well, while the gearing level of 7% added value.

However, the ultimate return to shareholders disappointed slightly due to small underperformance on a share price basis, returning 11.3%.

Rather than being attributable to Curtis’ stock/sector selection, this is due to the emergence of a marginal discount (-2.2%), from a position of a small premium at the start of the financial year. This was in keeping with peers, as the general trajectory of discounts for UK Equity Income trusts was one of widening.

For City of London such a discount is fairly seldom seen – the popular trust is more used to trading at a small premium and issuing shares. Shares were bought back throughout the year and the discount has all but closed since the period end (currently -0.5%). City’s consistently minimal deviation between discount and NAV is a rarity in the peer group, where the average discount is over -5% and many trusts trade nearer -10%.

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Given the trust’s objective and pedigree in growing income, investors will be keenly interested in the dividend payout. The trust produced dividend growth of 2.5%, marking an incredible 58 consecutive years of increasing payouts – the longest record of any UK investment trust. It is encouraging that the distribution of 20.6p is covered by earnings, which grew at a faster rate than the dividend payout, and that the “revenue reserve” is in good health.

Over the long term, the strong track record of capital growth and rising dividend payouts for City is very much intact. The trust’s conservative approach - using leverage relatively sparingly, while prudently focusing on businesses with strong balance sheets and good cash-generative abilities to support dividend payouts as well as reinvestment - has generated good long-term performance.

The portfolio of 80 to 90 companies invests across a range of sectors, and boasts a very diversified source of revenue across industries and geographies, with nearly two-thirds of revenues originating overseas. City’s management and board maximise the attributes of the trust structure, retaining a portion of income for the revenue reserve to assure future dividend payouts, and leveraging modestly to enhance returns over time (doing so at an enviably cheap rate).

The trust has been managed by Curtis since 1991, and he has more than four decades of experience. David Smith has worked with Curtis for over 10 years, and was appointed deputy manager in 2021 and both men benefit from Henderson’s large international analyst resource.

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The yearly ongoing charges figure (OCF) of 0.37% is the cheapest in its sector and, at well over £2 billion in size, the trust has good scale at a time where we are seeing rapid consolidation among smaller vehicles.

City’s yield of 4.9% outstrips comparable equity income peers (AIC UK Equity Income average yield of 4.2%,) and the FTSE All-Share index yield of 3.7%.

While the rapid onset of higher interest rates may have encouraged equity income investors to consider alternative sources of income, City of London offers a significant yield premium over the 10-year gilt, meaning the trust remains a very attractive proposition for income seekers.