Ian Cowie: why income seekers should size up lower yielding trusts

Our columnist takes a look at how three smaller company investment trusts that pay dividends have fared in total return terms.  

Perhaps the most expensive mistake this DIY investor persistently makes is to be too greedy about initial income, and not mindful enough about the ability to grow capital values and dividends over long periods of time.

That’s daft when my main investment aim is to fund an enjoyable retirement that might still be some way off and could last several decades. This is why I am now trying to focus more on investment trusts that can deliver growth plus sustained and rising payouts.

So, while most eyes were on a coronation elsewhere, I was impressed to see something of a princeling among investment trusts join the kings of dividend distribution last week.

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BlackRock Smaller Companies (LSE:BRSC), a £795 million stalwart of the Association of Investment Companies (AIC) ‘UK Smaller Companies’ sector is the latest to join the AIC’s elite band of ‘dividend heroes’, having succeeded in raising its dividends for 20 years without fail.

BRSC reported revenues per share of 40.9p in the year to February, compared to 35.3p during the previous year, an increase of 16%, and raised its dividend accordingly from 22p to 25.5p. Presenting the annual report, Chair Ronald Gould said: “Even if the initial dividend yield at the point of purchase has been unremarkable, the strong underlying growth in dividends over the years has resulted in a competitive yield on cost when compared with equity income funds in general.

“To illustrate this investment and income success, £1,000 invested in the BRSC in February 2006, would have increased in value by 442% in net asset value (NAV) terms to February 2023, whereas £1,000 invested in the UK open-ended income sector median would have increased by just 152%.”

Cynics in the crowd might well point out that BRSC’s current dividend yield remains just under 3%, which is not much to shout about. However, depending on your point of view, it might be more significant that its dividends have risen by an annual average of 9% over the last five years, according to independent statisticians Morningstar.

If that rate of ascent is sustained, which is not guaranteed, it would double shareholders’ income in just eight years. Whenever you want to know how many years it will take for income to double, simply divide 72 by the annual rate of increase.

Sad to say, the same thing works in reverse. If you want to know how long inflation will take to halve the purchasing power of money or compound interest will take to double a debt, then divide the same number by the annual rate of change. It’s called the ‘Rule of 72’.

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Here and now, BRSC has delivered the returns mentioned above from underlying holdings that include Gamma Communications (LSE:GAMA), which provides Unified Communications as a Service (UCaaS) to other British and European businesses; 4imprint Group (LSE:FOUR) , the marketing bumf company; and CVS Group (LSE:CVSG), which provides a wide range of veterinary services from diagnostic laboratories to pet crematoria.

Several other ‘UK Smaller Companies’ investment trusts can demonstrate success in raising dividends. Among those with more than £200 million in assets, Montanaro UK Smaller Companies (LSE:MTU) leads the field, having increased shareholders’ income by an annual average of just under 15.5% - which, if sustained, would double distributions in less than five years - and currently yields 4.2%.

MTU has delivered the dividends above from an underlying portfolio that includes Greggs (LSE:GRG), the Newcastle-based bakery famed for its sausage rolls; Clarkson (LSE:CKN), the shipping broker; and Dechra Pharmaceuticals (LSE:DPH), another veterinary specialist.

JPMorgan UK Smaller Companies (LSE:JMI) ranks third among ‘UK Smaller Companies’ investment trusts with total assets above £200 million and sustained payout hikes, with a dividend yield just above 2.5% that it has raised by an annual average of 8.5% over the last five years. JMI’s top holdings also include 4imprint Group (LSE:FOUR) and Premier Foods (LSE:PFD), the owner of brands including Bisto,  Mr Kipling and Oxo.

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How has all that translated into long, medium and short-term total returns? Among our triumvirate of trusts for rising income from UK smaller companies, JMI comes first with total returns of 159% over the last decade; first over five years with 24%; and second over the last year with 1.4%.

Over the same three periods, BRSC delivered 157% before a deeply disappointing 4.1% and then, worse still, a loss of 2.7%.

Meanwhile, MTU managed 67%, then 17% and came first over the last year with a gain of 4.3%.

Of course, what you see depends on where you are standing. Those total returns might look a lot more attractive if I had already retired and my time horizons were shorter, with more emphasis on income and less on capital growth. 

For good or ill, it is important to remember that the past is not necessarily a guide to the future. But the tantalising paradox remains that the price of a high and rising income today can often prove to be low or no capital growth tomorrow.