How do investment trusts meet income requirements?

Some of the AIC’s dividend heroes include investment trusts which have clocked up 50 years of consecutive dividend increases.

Figure 1: Dividend heroes

There are three trusts which have reached this significant milestone: City of London Investment Trust, Bankers Investment Trust and Alliance Trust.

The managers acknowledge the structural advantages of closed-ended funds, but there is more to it than that.

In a press release sent out by the AIC in March this year, Job Curtis, manager of the City of London Investment Trust explains: “City of London’s record of growing its dividend every year for 50 years has been achieved both by investing in good companies and also through the investment trust structure. 

“In the good years for dividends, we add to our revenue reserves which we are then able to use in more difficult periods. Indeed, in seven of the 25 years during my period as fund manager, we have dipped into revenue reserves to help grow the dividend.”

Alex Crooke, manager of the Bankers Investment Trust, recalls the trust last held its dividend flat in the year 1966, after a “bumper year” of dividends in 1965 when companies tried to avoid the introduction of capital gains tax for the first time.

He agrees: “The key is to invest in companies that themselves focus on cash generation and distributing dividends throughout economic cycles. The current outlook for income is more muted than previous years, partly because dividends, after lagging the recovery of corporate earnings post the 2008 crash, have now caught up. 

“Many companies in the US and Europe are now paying out a relatively high percentage of their earnings as dividends and therefore fund managers need to carefully focus on those industries where earnings are rising.”

Regular payouts

Investment trusts have responded to the growing need for income by increasing dividend payouts.

As QuotedData’s head of research James Carthew observes: “Many investment companies now make quarterly or even monthly dividend payments, a change which has progressed in response to demand and opportunity.”

Much of the growing demand for income has come from pension freedoms as savers seek ways of funding their retirement.

Does this mean investment trusts will find a place in retirement portfolios?

James Burns, a partner at Smith & Williamson, suggests they will as part of portfolio construction but cautions investment trusts “are not a perfect vehicle”.

“But from an income point of view they’re very useful for clients,” he says. “If you retire and you have a pot to pay some income into, you want that income to be consistently growing ahead of inflation and I’m not saying you couldn’t do that with just a portfolio of open-ended funds but you are more open to the vagaries of the broader market than you would be if you have the ability to smooth payouts from revenue reserves that trusts do.”