Income pledges of 11 investment trust ‘dividend heroes’ revealed

We examine stock-market reports issued by trusts with a history of increasing dividends to determine whether track records will continue in the dividend drought.

One of the key structural advantages that investment trusts have over open-ended funds is once again being put to the test as scores of companies cancel, suspend or axe dividend payments in response to the coronavirus pandemic.

Investment trusts do not have to distribute all the income generated by their underlying assets every year. Up to 15% can be held back each year, which means that they can build up a “rainy day” reserve to bolster dividend payouts in leaner years. In contrast, open-ended funds have to return all the income generated each year to investors.

During the financial crisis, the reserve funds were challenged and passed with flying colours, as the majority of investment trusts maintained or increased dividend payments.

In total, as interactive investor columnist Ian Cowie points out, 21 trusts have raised dividends for two decades or more and most look well placed to sustain their dividend distributions for at least another year. According to research by Winterflood Securities, 18 of the 21 Association of Investment Companies (AIC) “dividend heroes” have revenue reserves that exceed 100% of their current payouts. 

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While having sufficient reserves in place is a source of comfort to income seekers, particularly when dividends are drying up, the decision over whether annual increases are maintained is down to the independent board of directors.

With this in mind, we examined stock-market reports issued by the 11 investment trusts that have raised dividends for 40 years or more to find out whether pledges have been made to keep the track records going.

It makes for good reading, as all 11 look set to continue increasing dividends despite the challenging backdrop.

City of London (LSE: CTY) and BMO Global Smaller Companies (LSE: BGSC) have made annual increases, of 2.2% and 3%, respectively, while Caledonia Investments (LSE: CLDN) had a 3% increase scheduled for 6 August.  

Bankers (LSE: BNKR) and Alliance Trust (LSE: ATST), which are both hoping to match City of London’s 54 years of dividend increases, have signalled their intention to increase annual payouts by 3%. Both trusts intend to draw on their revenue reserves.

Others, however, are paying only a token dividend increase. Brunner (LSE: BUT), for example, has announced that it will increase annual payouts from 19.98p to 20.01p, which works out at a 0.15% rise, below the current very low rate of inflation of 0.6% in June. In 2019, Brunner hiked its annual dividend by 10.1%.

Murray Income (LSE: MUT) will next month notch up 47 years of dividend increases, but again, the dividend increase is small at 0.7%, with annual payouts rising from 34p to 34.25p.

Other trusts are playing their cards close to their chest in terms of the size of the dividend increase, but all have pledged, or are on track, to raise annual dividends.

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Simon Elliott, head of research at Winterflood Securities, notes that most experts are predicting a 40% to 50% decline in aggregate dividends across the UK market. In addition, the global market is expected to see a marked reduction in dividend payments, although not to the same extent.

Against this backdrop, he adds, it is pleasing to see that “dividend hero” trusts “have, in general, either reported dividend increases for the latest financial years, or expressed their intention to preserve their records. This will be achieved in most cases by the use of revenue reserves.”

But Elliott cautions that if the dividend drought continues for a prolonged period of time boards will have tough decisions to make.

He adds: “We believe that the AIC dividend heroes are, to date, living up to their billing in the main. However, we are conscious that the going might get tougher if it becomes clear that there will not be a swift return to the previous dividend payment levels from the underlying portfolio companies.

“Many are predicting that they will take the opportunity to rebase their dividends after over-distributing for years. Alternatively, a number of companies are expected to ‘return to the list’ sooner rather than later. We will have a better picture of this as we move through this year.”

Source: Association of Investment Companies and interactive investor research.