Investment trust investors turn to ‘dividend heroes’ to plug income gap

A dividend drought will negatively impact income seekers in 2020, but ‘dividend hero’ trusts look well placed to continue delivering increases.  

Income investors facing the challenge of finding reliable sources of income have turned to some of the “dividend hero” investment trusts to plug the gap, in the hope that boards will continue to increase income payments to maintain their reliable dividend records.

Of the 11 trusts that have increased dividends for 40 years or more, the majority have moved to trade on a premium or a small discount to their net asset value over the past couple of weeks.

City of London, which earlier this month took steps to reassure shareholders that it is in a position to increase its dividend in July for the 54th consecutive year, is trading on a premium of 5.9%. Over the past year, the trust has traded on a premium of 1.7%.

A higher premium of 7.4% is attached to Scottish American. The Baillie Gifford managed trust is 11th in the “dividend hero” rankings complied by the Association of Investment Companies (AIC), having increased payouts for 40 years.

Two other trusts on course to raise their dividends for 54 years on the trot are Bankers and Alliance Trust. Bankers is currently trading on a small premium of 1.7% and Alliance Trust a small discount of -4%.

Other trusts that have increased dividends for four decades or more and have low discounts include JPMorgan Claverhouse (-2.8%) Murray Income (-3.6%) and Brunner (-4.2%).

According to Numis, the low discounts, in particular for the UK equity income trust sector, are “reflecting investor hopes that dividends can be maintained using revenue/capital reserves”.

It adds: “We expect most boards to be faced with the decision of whether to use reserves to pay an uncovered dividend in 2020. Ultimately, we believe it makes sense to support dividends with revenue reserves if the shortfall is expected to be relatively short-lived, and there is an expectation of returning to full cover. We expect more reticence about distributing from capital reserves, but the line between capital and income is increasingly blurred.”

Numis further adds: “We would expect numerous investment trusts to be keen to continue their records of multi-decade years of consecutive dividend.”

Analysis at the end of March by the investment companies team at Investec Securities found that all 17 UK equity income investment trusts it analysed (although there are 24 in the sector as a whole) would be able to endure a 30% fall in dividend income from their underlying holdings over the next year, and still pay a progressive dividend (it modelled a 3% rise). The 30% figure was used because this is the dividend decline that is being priced in by the futures market.

- The UK equity income investment trusts in the best position to retain or increase dividends

However, given the increasingly challenging backdrop for dividends, some trusts in other sectors have already made adjustments. For example, BMO Commercial Property has suspended its monthly dividends, while Invesco Smaller Companies investment trust has removed its 4% dividend target yield.

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