In recent years investors have been forced into finding alternative sources of income. Returns from high street banks are poor at an average of 2.3 per cent and despite gilt yields rising to 2.0 per cent from 1.7 per cent in October, they are still way below equities. To add to this inflation remains high meaning income seekers are investigating how to generate income through other routes – notably equities and, in particular, investment trusts.
UK equities are yielding 4.0 per cent, and have the prospect of capital and income growth. According to the Capita UK Dividend Monitor, dividends will total more than £81.0bn in 2013, after a record £78.6bn in 2012.
Throughout 2012 speculation grew around what impact the retail distribution review would have on the investment trust industry. The view was that RDR would bring a boost to investment trust providers. The new rules that were enforced on 1 January meant that independent financial advisers could no longer earn commission on advising clients on investments thus creating a level playing field for investment trusts and mean more investors can, and will, access these investments in the future. Despite this a number of major platforms have confirmed they will not be offering investment trusts post-RDR. This will, of course, be problematic for IFAs who must review a broader range of investment options under the new rules.
As a fund manager of both investment trusts and open-ended investment companies, I know well the benefits that each can offer the retail investor, especially those seeking income. Although the issue at the moment is that many investors do not fully appreciate investment trusts and their benefits – investment trusts simply do not get the airtime as Oeics. This is perhaps because the investment trust universe is smaller at only 291 listed on the London Stock Exchange, compared to more than 2500 unit trusts and Oeics, many of which are heavily marketed.
In terms of generating a reliable and sustainable income, investment trusts are well equipped to offer reassurance and stability to income-seeking investors. The structure of an investment trust is efficient in that it has the ability to hold back up to 15 per cent of its revenue each year. So in essence this means a company can keep back some of its dividend income each year to create a reserve to fund future distributions, which Oeics cannot.
The board of the investment trust will then make the decision on how to distribute this income. It is often the case that, in the interest of providing its investors with a regular and consistent income, boards will choose to hold back dividends in some years to ensure they provide a smoothing of income distribution during less prosperous years.The golden rule for income-focused investment trusts, which will be music to the ears of income-seeking investors, is they do not cut dividends.
Many investment trusts will in fact adopt a progressive dividend policy in order to sustain an increased dividend for investors each year. The AIC has published dividend tables to demonstrate a number of investment trusts that have been paying consecutive growing dividends for a number of years and examples of these are The City of London Investment Trust, The Bankers Investment Trust, and Alliance Investment Trust. This dividend policy, exclusive to investment trusts, gives predictability of income which, at present, is an excellent benefit given the low yields from bonds.
