3 min read 28 Apr 22
Investment trusts have delivered excellent long-term returns for shareholders for over 150 years, but are still sometimes referred to as ‘The City’s best-kept secret’. In the second article of a series from Baron & Grant Investment Management Limited, John Baron, Chair of the Investment Committee, highlights the merits of investment trusts for those investors seeking income.
One of the key structural advantages of investment trusts is their ability to build up ‘Revenue Reserves’. Unlike open-ended funds, in any one-year investment trusts can retain up to 15% of their dividends and income received from holdings in the underlying portfolio. This reserve can be used to supplement dividends going forward to help ensure a smooth progression even when, within reason, the underlying economy and/or markets go through a rough patch and portfolio holdings see dividend cuts.
Data from the Association of Investment Companies (AIC), the respected trade body for investment trusts, has shown that 85% of those investment trusts focused on paying income maintained or raised their dividends during the pandemic, compared to just 23% of equivalent open-ended funds – this is a proud record given the market backdrop. Understanding the extent of reserves is a key factor when selecting relevant investment trusts.
Indeed, the use of such reserves has helped many investment trusts increase their dividends every year for over five decades. The AIC maintains a ‘Dividend Heroes’ list (Correct as at 11th February 2022) which highlights the investment trusts that have consistently increased their dividend for a minimum of 20 years. There are currently 17 trusts on the list - City of London (CTY) and Bankers (BNKR) topping the list with 55-years of consistent growth. It is worth noting that trusts with a very strong dividend record can, at times, trade at a premium to the value of the assets they invest in. This can make accessing the ultra-reliable income streams relatively expensive for new investors.
Legislative changes now also allow investment trusts to dip into their capital to supplement or pay a dividend. More trusts are doing this which, within reason, is welcome as it can better allow investors seeking income to gain exposure to low-yielding but high-growth sectors such as smaller companies and healthcare.
Further research from the AIC shows 36 investment trusts have increased their dividends over the last five years by more than the Consumer Prices Index (CPI), while delivering an annualised share price return (excluding dividends) of more than 2.5%. No trust on the list cut their annual dividend. While the past is not a guide to the future and inflation-beating returns are far from guaranteed, many investment companies are focused on growing shareholders’ income and capital in real terms.
Being closed-ended, investment trusts are also better suited for certain types of long-term, less-liquid investments. The closure of a number of open-ended property funds during the mistaken rush to the door following the EU referendum highlighted the suitability of their structure for this type of investment. Other assets such as private equity and smaller companies also require the incubator effect best offered by the structure of investment trusts, courtesy of their very nature and therefore at times illiquidity.
Investment trusts, unlike open-ended funds, can also borrow money to buy more assets (‘gearing’). Historically, this has benefitted asset values and share prices in part because markets have risen and because good fund managers have capitalised on this gearing. If the additional capital is invested in assets which produce income, this can help to boost dividends. However, most investment trusts are right to use only modest levels of gearing, as it can increase volatility and risk.
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