Interactive Investor

‘Dividend hero’ trusts to continue using reserves to plug income gap

8th September 2021 09:00

Kyle Caldwell from interactive investor

Some investment trusts appear to be cautious, despite various firms resuming dividend payments.  

Investment trust ‘dividend heroes’, those with formidable track records of increasing income payouts through both good times and bad, have indicated that they will continue to utilise their dividend reserves in the event an income shortfall plays out for a second successive year.

Research by interactive investor, which examined the latest half-yearly or annual reports of 11 trusts that have raised dividends for more than 40 years, found numerous mentions of boards giving their blessing over the continued use of dividend reserves to help increase payouts this year if the underlying investments do not generate enough income.

Various firms have returned to paying dividends this year, with the latest edition of the Janus Henderson Global Dividend Index showing that 84% of companies either increased their dividends or held them steady in the second quarter compared to the same period in 2020.

In addition, UK dividend payments beat expectations in the second quarter. Although unlike global dividends, which are now projected to return to their pre-pandemic levels within the next 12 months, the expectation is that it will take until 2025 for UK dividends to do the same. UK dividend payments hit record levels for three years on the spin in 2017, 2018 and 2019.

Some investment trusts appear to be cautious over their ability to pay a rising dividend this year solely through the income earned by the underlying companies the trust invests in.  

One reason for such caution is perhaps down to the fact that investment trust dividends always lag behind the wider market. This is because trust dividends are paid from the dividends distributed by the companies the trust invests in. Therefore, depending how much is generated from the underlying investments and the time of year the trust pays its dividends, the trust may not have enough income in the dividend till to write a higher income cheque than it paid the previous year.

City of London (LSE:CTY), which is expected to this month report its 55th consecutive year of dividend increases, told the market in February (in its half-year report) that its “diverse portfolio, strong cash flow and revenue reserve give the board confidence” that its track record can be maintained.

More recently, over the past couple of months, Brunner (LSE:BUT), JP Morgan Claverhouse (LSE:JCH) and Witan (LSE:WTAN), have all indicated that dividend reserves will likely be used.

The global-focused Brunner said in its half-yearly report (on 21 July) that it “continues to have strong revenue reserves which exist to support dividend payments in times when earnings are constrained. The board intends to continue to use these reserves as necessary to maintain our steadily growing dividend while earnings recover to a level where the dividend is covered. Encouragingly, the manager is seeing dividend payment expectations improving slightly beyond expectations for the year ahead and keeping us on track to return to covering the dividend in future years.

JP Morgan Claverhouse, which invests in UK dividend-paying companies, noted in its half-yearly report on 6 August that “while portfolio companies are beginning to increase their dividends from the cuts and suspensions seen in 2020, it is likely that, as with last year, the company's full dividend for 2021 will require some utilisation of the revenue reserves. The board currently intends to declare an increased dividend for 2021, compared with that for 2020.”

Similarly, in its half-yearly report on 8 August, Witan said: “The board has stated its willingness to continue to smooth dividend payouts using revenue reserves.”  

Most other dividend heroes stressed in their latest half-yearly or annual results that their dividend reserves are in a strong position.

Analysis by interactive investor in June found that most investment trust dividend heroes are in a robust position to grow their distributions to shareholders. Most have the equivalent of more than a year’s worth of dividends in their reserves.

How the revenue reserve actually works

It is easy to get the impression the revenue reserve is somehow ‘ring-fenced’.  But that’s not the case. In reality, it amounts to little more than an accounting tactic, an entry in the books to show retained revenue. That money is part of the trust’s net asset value (NAV) and is invested in the same way as the rest of the portfolio. If some of it is needed to top up dividend distributions, then the manager has to sell holdings or dip into the cash element and the NAV is affected. 

A downside with the dividend heroes, as the table below shows, is that most have low dividend yields at present.

The 11 dividend heroes with more than four decades of increasing income payments 

Investment company AIC sector Dividend yield (%) Number of consecutive years dividend increased
City of London UK Equity Income 4.8 54
Bankers Global 1.8 54
Alliance Trust Global 1.4 54
Caledonia Investments Flexible Investment 1.8 54
BMO Global Smaller Companies Global Smaller Companies 1 51
F&C Investment Trust Global 1.4 50
Brunner Global 1.9 49
JPMorgan Claverhouse UK Equity Income 4.1 48
Murray Income UK Equity Income 3.7 47
Scottish American Global Equity Income 2.3 47
Witan Global 2.2 46

Source: Association of Investment Companies. 

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