Ian Cowie: UK equity income trusts are the place to be in 2023

Our columnist looks back at how investors switching from ‘jam tomorrow’ to ‘jam today’ has benefited UK dividend-paying investment trusts this year, a trend that looks set to continue in 2023.

British shares beat American stock market indices and most overseas rivals in 2022 as financial fashion switched from hopes of capital growth tomorrow to focus on dividend income today. During a difficult year for investors, the FTSE 100 benchmark of Britain’s biggest shares slipped 2% lower, while America’s blue chip Dow Jones index fell 10% and its technology-led Nasdaq plunged by an eye-watering 33%.

Analysis by fund firm Schroders suggests that the London Stock Exchange is the top performer among all the world’s major markets in 2022. That’s the first time London has been the global leader, on the basis of this analysis, in more than a quarter of a century.

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Similarly, while the average investment trust of any description suffered 16% shrinkage in 2022, according to Morningstar, the average UK Equity Income investment trust slipped less than 1% lower. Better still, the average share in this sector continues to yield 4.1% dividend income and trades at a modest 2.3% discount to its net asset value (NAV).

City of London (LSE:CTY), a ‘dividend hero’ that has increased shareholders’ income every year without fail for 56 years, also led the ‘UK Equity Income’ investment trust sector during 2022. It delivered total returns of 8.5% during a year when capital markets became collateral damage in Europe’s worst war since 1945.

This £1.98 billion giant continues to yield just under 5% income, having increased dividends by an annual average of 3.3% over the last five years. Its total return over that latter period was a modest 18%, while it produced a more satisfactory 98% total return over the last decade.

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Less happily for investors who would rather not profit from products that kill their consumers, its biggest underlying holding is in British American Tobacco (LSE:BATS). Another cancer company, Imperial Brands (LSE:IMB), also features in its top 10.

Other major holdings in the oil giant Shell (LSE:SHEL); the brewer and distiller, Diageo (LSE:DGE); and the armaments group BAE Systems (LSE:BA.) may also raise ethical eyebrows.

Another worry is that City of London’s unrivalled record of sustaining rising dividends has lifted its share price to trade at a 2.1% premium to NAV.

BlackRock Income and Growth (LSE:BRIG) ranks second in the UK Equity Income sector over the last year with a total return of 7.2%, following 13% over five years and 91% over the last decade. Its top 10 holdings are led by the pharmaceutical giant AstraZeneca (LSE:AZN), followed by Shell and the business information group, RELX (LSE:REL).

Sad to say, British American Tobacco also features in the top 10.

More positively, it all adds up to a dividend yield of 3.8%, which has risen by an annual average of 2.7% over the last five years but this investment trust still trades at a 4.7% discount to NAV.

Merchants Trust (LSE:MRCH) ranks third in this sector over the last year with a total return of 4.4%, following 48% over five years and 143% over a decade. Its major underlying assets are led by Shell, followed by British American Tobacco and the pharmaceutical giant GSK (LSE:GSK) - formerly known as GlaxoSmithKline. Imperial Brands and BAE Systems also feature in its top 10.

Merchants is another ‘dividend hero’, having increased its dividends annually without fail for 40 years. It currently yields just under 5% income, having raised payouts by an annual average of 2.4% over the last five years. The shares trade 1.3% above NAV.

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Income-seekers who favour longer-term outperformance might prefer Law Debenture Corporation (LSE:LWDB), which is the UK Equity Income sector top performer over five years with a total return of 50% after delivering 156% over the last decade. Its one-year return is 3.5% and the dividend yield is 3.8% after achieving annual payouts growth averaging 11.7% over the last five years.

Law Debenture’s major holdings are led by Shell, followed by rival oil giant BP, plus a triumvirate of banks: HSBC (LSE:HSBA), NatWest Group (LSE:NWG), and Lloyds Banking Group (LSE:LLOY). Armaments and tobacco stocks are notable by their absence from this top 10. The shares trade 2% above NAV.

Merchants came second over five years while Dunedin Income Growth (LSE:DIG) ranks third over this period with a total return of 36%, following 84% over the decade and shrinkage of nearly 9% over the last year. A portfolio led by AstraZeneca, plus the consumer goods giant Unilever (LSE:ULVR), followed by Diageo and RELX, yields 4.6% income that has risen by an annual average of 2% over the last five years. Dunedin Income Growth’s top holdings are also free of armaments and tobacco while it trades at a 2.6% discount to NAV.

Rising interest rates and double-digit inflation mean investors might have to pay more attention to dividend income in future than they did in the recent past. The opportunity cost of holding ‘jam tomorrow’ growth stocks is no longer negligible, and the UK Equity Income sector may enjoy a long overdue return to favour.

Ian Cowie is a shareholder in Diageo (DGE) and Unilever (ULVR) as part of a globally diversified portfolio of investment trusts and other shares.