UK equity income trusts deliver dividends and outperformance

As well as navigating the dividend storm, majority of UK dividend trusts have outperformed over the past decade.

Dividend payments from investment trusts in the UK equity income sector have staged a remarkable comeback since the carnage of the pandemic-induced market crash in spring 2020.

A new research note from Investec highlights the sector’s impressive results in terms of both dividend resilience and long-term total returns.

Despite the fact that UK dividends fell 43% last year, following suspensions and reductions in payouts, 12 of the 16 trusts under consideration in the Investec note have maintained rising dividends through the period, while another one, Finsbury Growth & Income Ord (LSE:FGT), has held steady.

Only three - Edinburgh Investment Ord (LSE:EDIN), Temple Bar Ord (LSE:TMPL) and Troy Income & Growth Ord (LSE:TIGT) – have had to cut payouts, and the latter was in the process of shifting its focus to a higher-growth, lower-income focus anyway. Meanwhile, both Edinburgh Investment Trust and Temple Bar had recently appointment new management groups.

The UK equity income sector has been buoyed by a powerful recovery in dividend payments from UK-listed companies during the third quarter of 2021. Link’s third quarter UK Dividend Monitor found headline dividends grew by almost 90% compared with the same time in 2020, on the back of “some very large one-off specials” from mining companies, while underlying dividends were up 53%.

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At the same time as preserving their progressive dividends in most cases, 14 of the 16 UK equity income trusts featured in the report have managed to outperform the FTSE All-Share over 10 years.

Investec highlights Finsbury Growth & Income and Diverse Income Trust Ord (LSE:DIVI), both with annualised net asset value total returns of more than 13% over 10 years, which compares impressively with the FTSE All-Share’s 7.3%. Other standouts include Invesco Select UK Equity Ord (LSE:IVPU), Law Debenture Corporation Ord (LSE:LWDB) and Merchants Trust Ord (LSE:MRCH).

Dividend heroes didn’t let investors down  

For the full year of 2021, Link expects headline UK dividend growth of 45% and underlying growth of 22%. Dividends are forecast to continue rising in 2022, boosted by bank payouts, though not at the spectacular rate seen this year.

Importantly for the UK equity income sector, the recovery in corporate payouts is already feeding through to investment trust earnings per share, which had been hit by the falloff in corporate dividends. The team at Investec “expect this trend to continue in the coming months, as the strong rebound in second quarter and third quarter dividends is reflected in forthcoming [investment trust] interim and final results.”

However, the key to trusts’ capacity to continue paying progressive dividends even through the depths of the past 18 months has been access to their revenue reserves - one of the great structural advantages of closed-ended funds compared with open-ended peers.

Indeed, observes Andrew McHattie, publisher of the Investment Trust Newsletter, the pandemic provided a true test of this ability to ’smooth’ dividend payments using reserves. “Effectively, by keeping some income in reserve during normal times, investment trusts are able to build a buffer for rainy days, when normal dividend flows are interrupted.

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“During the deluge of dividend cuts that hit the UK as a result of Covid-19, this system was tested under a high level of stress, and passed with flying colours,” he explains.

“The trusts that have been able to maintain unbroken records of dividend growth for decades, through all sorts of crises, have earned their famous ‘dividend heroes’ tag,” he adds. “Heroes don’t let you down in a crisis, and they didn’t this time.”

The Investec team agrees that the potent combination of recovering corporate dividends and strong revenue reserves “has given boards confidence to maintain progressive dividends in 75% of the companies featured in this report”. It’s a stark contrast with the UK equity income open-ended fund sector, where dividends were cut by an average 29% in 2020.

McHattie makes the point that dividends may still not be covered by income again this year, so there will be a further dip into reserves for many trusts, but “many managers believe a strong recovery in dividends will allow full cover to be restored in 2022”.