Investment trusts are well known for their capacity to deliver consistent, growing dividends. This is in part due to their ability to hold back some of their income each year to cover dividends in difficult times.
They can therefore pay out during periods when open-ended funds struggle to maintain dividends.
Tradition often also plays a key role in perpetuating this pattern, as investment trusts' boards strive to meet shareholders' implicit income expectations, while many trusts are simply mandated to pay regular, growing dividends.
A number of older, well-established trusts have consistently grown their dividends for decades. According to the Association of Investment Companies (AIC), Money Observer Rated Fundsand have grown their dividends for 48 consecutive years, while a further 32 trusts have grown their dividends for 10 consecutive years or more.
Inflation beating income
However, while dividend growth is certainly welcome, it is important that the pace of growth keeps up with price rises - in other words, inflation.
The effect of inflation on savings and investments is often underestimated (not least when inflation is at record lows). Few investors consider how it affects their real returns - investment returns after inflation has been accounted for.
As the cost of goods and services rises, the amount that can be bought for a given amount of money reduces. This means that savings or investments sitting in a bank account or portfolio and not generating a return (whether in the form of income or capital growth, or both) at or above inflation are actually falling in real value.
Such has been the case for cash savings over the past five years, as the Bank of England's quantitative easing policy kept interest rates at historic lows. Fixed-income investors have also suffered in the face of suppressed bond yields.
In contrast, because investment trusts have a structural advantage when it comes to maintaining a steady stream of growing income, they are particularly useful in the fight against inflation.
Over the past 10 years, the average annual rate of inflation has been 3.1%. Encouragingly, of the 34 trusts that have grown their dividends for 10 consecutive years or more, only two have posted growth rates below this level.
The laggards are, which is in the AIC's UK equity income sector, and , a UK all companies trust - both of which have grown their dividends at an average rate of just 2.7% a year since February 2005.
The median rate of annual dividend growth among the remaining 32 trusts is a healthy 5.7%, which means that most of our "dividend heroes" are growing their dividends meaningfully every year.
Boasting the highest rate of dividend growth is Money Observer Rated Fund, which has delivered an average annual dividend growth rate of more than 25% since February 2005.
In second and third place areand , both of which invest in the Asia Pacific region and have produced average annual dividend growth rates of 16.2% and 15.5% respectively.
Capital growth counts
Encouragingly, 33 of our 34 dividend heroes have also managed to grow their capital, or net asset values (NAVs), ahead of inflation over the past 10 years. In fact, discounting loss-making Aurora's numbers, the lowest rate of annual average NAV growth over the period is 6%, almost double the average rate of inflation.
Capital growth, often forgotten in the insatiable hunt for yield, is an essential component of income growth.
Ben Yearsley, head of investment at Charles Stanley, says: "You generate your income from the value of your capital, so if the capital isn't growing, the income will have little chance of growing either. This is why equities are important for long-term portfolios: they provide an opportunity to match and beat inflation."
However, as is often the case in investing, a fine balance of both growth and income provides the best results. Numerous studies have shown that equity income trusts and funds have an advantage over pure growth vehicles over the long term, as reinvested dividends significantly boost total returns.
For example, during the 15 years to 28 February 2015, the AIC's UK equity income sector returned 204% in terms of share price gains, compared with 155% from the UK all companies sector (where dividend payouts are much less prevalent).
The figures are even more startling in the open-ended space. The Investment Association's UK equity income sector returned 176% over the same period, compared with just 97% from the IA UK all companies sector.
The case for the all-rounders
Of course, for investors who need their income immediately, the compounding effect of reinvested dividends will be far less significant than their absolute level.
On this point, it is interesting to note that only 11 of our 34 dividend heroes pay an absolute yield above the current level of long-term inflation (3.1%).
The highest-paying trust, with a 4.9% annual dividend yield, is Merchants, while the lowest-paying trust is, which actually pays out no dividend at all, although it receives small payments from its holdings.
What is notable here is that Merchants has posted a below-inflation level of annual dividend growth since 2005, while Athelney is technically growing its dividend at more than 10% a year.
This is simply because it is far easier to grow a dividend from a low base than it is to maintain a dividend at a high level, where any increases are likely to be pretty small.
This is an important point to remember when assessing a trust's dividend growth: while maintaining a consistent, growing dividend is to be applauded, it may not be much use to you if the real yield is nominal.
For those who rely on their investments for regular income - such as retirees - sustainability involves finding a trust that both provides a competitive absolute yield and grows its dividends at above the rate of inflation.
Of our dividend heroes, 10 trusts currently provide a good balance of yield and dividend growth (see table, click to enlarge). Of these, Money Observer Rated Fund, a global equity trust, pays the highest absolute yield (4.3%) and has an annual dividend growth rate of 4.9%.
UK equity income trusthas the highest rate of dividend growth (5.7%) and currently yields 3.3%.
Secure source of stability
Few of our dividend heroes - particularly among those offering both above-inflation absolute yields and above-inflation dividend growth - deliver spectacular rates of either capital growth or income.
Far higher growth can be found in sectors such as biotechnology, where annual NAV returns have topped 60%, while yields approaching 10% are available from debt and infrastructure trusts. However, our dividend heroes offer more stability than these options.
That does not mean, though, that specialist vehicles do not also have a place in an income seeker's portfolio. Yearsley puts this into perspective. He says: "Private investors" portfolios should have a mix of stable higher yielders and some that maybe have a lower starting yield but have the ability to grow that income more quickly.
"Specialist trusts don't necessarily have to be more volatile; it is simply that by investing in them you are tying your fortunes to a much smaller and more homogenous group of companies.
"For example, at the moment solar energy trusts yield more than most [investments] and are inflation linked, but they are one small sector."
This point is an important one. Infrastructure trusts are increasingly becoming recognised as inflation-beating income investments that often enjoy the stability of government contracts and subsidies.
However, with the average share price to NAV premium in the infrastructure sector now exceeding 10%, most of these vehicles are expensive options for new investors. Moreover, few of these trusts boast the pedigree of Money Observer's dividend heroes.
For the 34 trusts we have highlighted, the average period of consecutive dividend growth is 25 years and the average absolute yield is 2.5% - both respectable ratios. In addition, annual NAV growth is 9.4%.
As already highlighted, equity vehicles tend to offer greater opportunity for long-term growth, with the AIC's global sector, for example, returning 130% in share price gains in the 10 years to 2015, compared with just 45% from the infrastructure sector. Income seekers can siphon some of those gains off in the same way they would take dividends.
Thus, for those seeking income stability, consistent dividend growth and inflation-beating capital growth, our dividend heroes represent a good place to start.
They boast impressive dividend records, but have also proved themselves solid workhorses in their sectors, particularly those boasting more than a century of trading history, such as, , and City of London.
The key is to home in on those that fit your growth and income expectations, and then keep a close eye on how they keep pace with growth in the real world.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. 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.