UK Edition
Last week we hailed the record of investment trusts in maintaining the flow of dividends even as payouts across the stock market dried up in the pandemic. But they aren’t out of the woods yet.
Trusts largely passed last year’s income test with flying colours: they raised their divis by 2pc over the 18 months to the end of June while payouts from British stocks crashed by 35pc and globally they were 6pc lower.
But this year, paradoxically, when dividends across global markets are recovering from last year’s pandemic hit, could provide a steeper challenge.
That’s because trusts had to dig deep into their revenue reserves in 2020 to maintain, and in many cases raise, their own dividends while the income they received from their holdings fell.
Now, with some of those reserves depleted and dividends across the stock market still below pre-pandemic highs, trusts could face an even sterner test to maintain or raise payouts again.
The pressure is most acute for trusts that derive their income from British stocks, which have cut divis the most. As we wrote last week, two such trusts tipped here, Temple Bar and Troy Income & Growth, have already delivered dividend cuts while a third, Edinburgh, has warned that one is coming.
The most useful measure of investment trusts’ dividend health is their revenue reserves. Trusts report this figure in their half-year and annual results, normally as the absolute amount in millions of pounds.
As an example, City of London, tipped here in 2018, last reported revenue reserves of £36m in its results for the six months to the end of December. In isolation, this number means little. To better gauge how much firepower reserves can give the board to supplement dividends, it helps to work out how much the figure equates to per share. In City of London’s case it is 8.68p.
When the trust has declared, but not yet paid, a dividend for the period to which the results relate, that needs to be subtracted from the figure. So City of London’s 8.68p per share falls to 3.93p once its second-quarter payout of 4.75p is accounted for.
That 3.93p figure can then be divided by the annual payout for the trust’s last financial year, 19p for City of London, to show what proportion of that dividend the reserves could cover. Just a fifth, or 21pc, is the answer. That is one of the lowest levels among our income trust picks, all of whose revenue reserves have been depleted over the past 12 months.
Perhaps it’s no surprise that Temple Bar and Troy Income & Growth have the least left, at 14pc and 8pc respectively, given that both have already bitten the bullet and cut divis. Reserves are also looking low for Lowland, a 2016 Questor tip, and Merchants, tipped last year. Analysts at Numis, the stockbroker, have calculated them at 16pc and 23pc of their last annual payouts respectively.
Aberdeen Standard Equity Income, a “hold” last week, has reserves equating to half last year’s annual dividend. JP Morgan Claverhouse, tipped for the Income Portfolio last year, has the most at 88pc, while Law Debenture, a 2017 pick, holds around three quarters. So too does Edinburgh, despite its looming cut, while Schroder Income Growth, first tipped for the Income Portfolio in 2016, holds reserves equating to 70pc of its last annual payout.
So where next for the trusts running low? City of London stands out, given that its low level of reserves is coupled with a proud dividend record. This year’s 19.1p payout, up from 19p last year, will mark the 55th consecutive year of dividend increases.
What chance of a 56th, or a 57th for that matter? Higher than you might expect. That’s because investment trusts have another weapon at their disposal to protect their dividends. Since a change in the tax rules in 2012, trusts have been allowed to raid their capital reserves – in other words, sell shares – to pay their dividends.
Income trusts that invest in British stocks have largely continued to fund their dividends the traditional way, from the divis they receive from their investments. That may now change.
Questor advises readers to continue to hold our income trust picks. Dwindling reserves are unsurprising given the crash in stock market dividends and shouldn’t be the spur to sell.
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