Interactive Investor

Ian Cowie: superheroes’ reserves are lifeline for income investors

13th August 2020 10:43

Ian Cowie from interactive investor


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Research reveals the 21 ‘dividend hero’ investment trusts well placed to weather the dividend drought. 

Now that half the constituent companies of the FTSE 100 index have cut or cancelled their dividends this year, income-seeking investors may feel like an endangered species. Even tried-and-tested equity income waterholes are drying up.

That’s bad news for those of us hoping to use newish pension freedoms to remain invested in retirement and live off stock market returns. But good news can be found in new analysis of the Association of Investment Companies (AIC) “dividend heroes” - that is, investment trusts which have increased income payments to shareholders for 20 consecutive years or more.

According to Winterflood Securities, 18 of the AIC’s 21 dividend heroes have revenue reserves that exceed 100% of their current payouts. So, these “fully funded” superheroes could sustain their current dividend distributions for at least another year, even if every one of the stocks in their underlying portfolios made no payout at all.

While fears persist that a second wave of the coronavirus might smash economic recovery, these investment trusts’ super reserves provide some reassurance. But the risks are real enough in extraordinary times; the oil giant Royal Dutch Shell (LSE:RDSB) cut its dividend for the first time since the Second World war in April and its rival BP (LSE:BP.) followed suit last week. 

On a brighter note, Winterflood’s research found several investment trusts have used their unique ability to retain some returns in good years to sustain payouts in bad years to substantial effect. For example, Winterflood reckons Alliance Trust (LSE:ATST) now has revenue reserves that equal 237% of the dividends it distributed last year.

While ATST currently yields only 1.8%, it has increased shareholders’ income by an average of 7.3% per annum over the last five years. So, if that rate of rise was maintained, which is not guaranteed, dividends would double in less than a decade.

Similarly, Witan (LSE:WTAN), another giant of the AIC global sector, yields 3.1% and has reserves equal to 186% of dividends, which have risen by an annual average of 11.7% over the last five years. If that rate of increase was sustained, dividends would double in just over six years. 

Here and now, Winterflood calculates that the average yield across all 21 of the AIC’s dividend heroes is an inflation-busting 4.5%. That yield is precisely matched by Murray Income (LSE:MUT), whose reserves equal 111% of dividends, and exceeded by Perpetual Income & Growth (LSE:PLI), whose yield of 6.9% is covered by reserves of 101%.

However, the well-publicised woes of PLI - which has shrunk shareholders’ capital by -17% this year and by -33% over the last five years, prompting an agreed merger with MUT - demonstrate that a high yield can result in low or no capital returns. Independent statisticians Morningstar via the AIC also calculate that MUT’s total return was -1.6% over the last year, but a positive 32% over the last five years.

Simon Elliott, head of research at Winterflood Securities, told me: “It is very important to understand that there are no guarantees from the dividend heroes or any investment trust that they will be able to sustain their payouts forever.

“But dividend heroes are in a stronger position than most and those with substantial revenue reserves can buy time to make difficult decisions later. Most of the dividend heroes have said it is their intention to use reserves to continue raising dividends.” 

Invesco Income Growth (LSE:IVI), JPMorgan Claverhouse (LSE:JCH) and Schroder Income Growth (LSE:SCF) are dividend heroes with high yields plus reserves exceeding 100% of payouts. With yields of 5.1%, 5.3% and 5.4%, their reserves are 103%, 119% and 143%, respectively.

The attractions of IVI, JCH and SCF are enhanced by average annual increases in dividend distributions over the last five years of 3.1%, 7.7% and 4.2%. But, once again, it must be said that total returns have been disappointing recently, with all three in the red over the last year.

Investors who seek a mixture of income and growth may obtain higher total returns by accepting lower dividends initially. To return to where we began, ATST has the lowest yield of any of the trusts mentioned but one of the highest rates of income growth, plus the highest five-year total return. Patience can pay off for investors and well-covered dividends make it easier to wait.
Ian Cowie holds shares in Royal Dutch Shell (RDSB).

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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