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The relief of revenue reserves

The relief of revenue reserves, Job Curtis

How our trust grows dividends year after year.

There is no question that we find ourselves in uncertain times.

But during periods of uncertainty, the investment trust structure has distinct merits. That is because investment trusts, which are listed companies, can store future income away for a rainy day – a unique function of investment trusts called revenue reserves.

Revenue reserves are how investment trusts can continue to grow their dividends even when dividends across the stock market are falling, typically during economic downturns. 

Investment trusts do not have to distribute all of their income in each financial year. They are allowed to hold back up to 15% of their annual income. For example, in a good year for investment income, an investment trust might hold back 5% of its income, while distributing the other 95% in dividends to its shareholders. The 5% that is held back will be added to the revenue reserve. 

Over the years, the revenue reserve can build up to a substantial sum if the investment trust is able to make further retentions.

In contrast, during an economic recession, there will be dividend cuts. If during these times an investment trust’s income from its portfolio declines, it is still possible to grow its dividend by drawing down from the revenue reserve. Obviously, revenue reserves are finite and so using the revenue reserves to sustain dividend growth can only take place for a limited number of years. The revenue reserve of an investment trust is revealed each year in its annual report and accounts. The largest revenue reserves tend to be found in old investment trusts which have accumulated them over many years.

City of London’s use of revenue reserves

We have grown the City of London Investment Trust dividend every year for more than 27 years. 

We have had to use revenue reserves in seven years to increase the dividend. 

Our financial year ends on 30 June, and many of us remember how difficult it was for world equity markets over the 12 months to 30 June 2002. In those 12 months, City of London’s earnings per share (including all its investment income) fell by 11% to 7.48p and yet we were still able to increase the dividend per share by 5.9% to 7.94p. 

The 0.46p difference was paid from the revenue reserve. 

The following year to 30 June 2003 earnings per share recovered by 5.2% to 7.87p, but it was still not enough to cover the dividend per share, which we increased by 1.6% to 8.07p using the revenue reserve. 

The next year to 30 June 2004 earnings per share grew by 4.7% to 8.24p, but again failed to cover the dividend per share, which grew by 3.2% to 8.33p. It was after three years of using revenue reserves, in the 12 months to 30 June 2005, that the dividend per share of 8.62p (up by 3.5%) was covered by earnings per share of 8.88p (up by 7.8%) and revenue reserves were once again replenished.

In City of London’s portfolio, we aim to invest in companies that can consistently grow their profits and dividends through the cycle. 

During economic downturns, there are bound to be companies that disappoint. Open ended investment companies (Oeics) must distribute 100% of their income each year and are not permitted to have a revenue reserve. We would not have achieved all those years of annual dividend increases if we had been managing an Oeic. 

City of London’s annual dividend stood at 4.56p in 1991. The quarterly dividend is now 4.75p and the investment trust’s board of directors has announced that it intends to pay an annual dividend of 18.60p for the year to 30 June 2019.