Investment Trust Dividends
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Real estate investment trusts (REITs) are designed to support investors in building a reliable second income.
In exchange for breaks on corporation tax, these entities must pay 90% of profits from their rental operations out in the form of dividends. Many of these property investment trusts even regularly exceed this threshold.
A Snowball grows bigger as it travels along.
The Snowball’s income for 2024 was £10,796.00
The fcast for 2025 is £9,120 with a target of 10k
All dividends received are invested back into the Snowbal
The income fcast, after year ten is £15.5k
The Target is £17.2k
Increasing yearly if you have longer to re-invest the dividends.
I will publish the current Snowball portfolio next week but your portfolio should reflect the number of years before you want to withdraw your income, you don’t have to wait to retire and your risk/reward tolerance, so it should be different to the current Snowball.
Mark Hartley outlines his long-term plan to earn a lucrative second income in retirement by investing in high-yield dividend shares.
Posted by Mark Hartley
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.
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There are few things in this world more enjoyable than earning cash without lifting a finger. That’s the beauty of investing in dividend shares. The regular payments sent to shareholders feel like free money sent from above.
That’s why I’m on a life-long mission to build a steady passive income stream from dividends.
First, I must build up my portfolio’s value through the miracle of compounding returns. Initially, I can accelerate this process by reinvesting my dividends. I can further optimise my growth with a Stocks and Shares ISA, allowing me to invest up to £20,000 per year with no tax on the capital gains.
Once the pot is large enough, I can start withdrawing my dividends as income and enjoy a comfortable retirement.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
What’s the catch?
Does the above sound too good to be true? I’ll admit, it isn’t easy — but it is possible! For it to work, three things are required: patience, dedication and a market-beating portfolio of the best dividend stocks in the UK.
Choosing the right dividend stocks isn’t always easy. There are several factors to consider, like the yield, payout ratio, and dividend growth history. It’s equally important to assess the financial stability of a company by checking its debt and cash flow.
The ideal dividend stock has strong cash flow, a sustainable payout ratio, and a history of increasing dividends. A high yield is great, but only if the company can afford to maintain it.
How to build wealth with dividends
An investment of £10,000, in a portfolio yielding 7%, would generate £700 in annual dividends. Reinvesting these payouts means the portfolio would grow modestly and could double in just over 10 years.
With the contribution of a further £3,000 per year to that portfolio, it could soar beyond £70k in 10 years. In 20 years, it could be over £200k, paying dividends of £7,500 per year.
That’s the power of compounding — turning today’s dividends into tomorrow’s wealth.
Stock picking
Achieving a portfolio yielding 7% requires very careful stock picking. Long-term dividend investors tend to avoid popular, trending stocks and opt for safe, boring companies.
Gas and electricity supplier National Grid (LSE: NG.) could fit the bill. It’s often cited as one of the best UK dividend stocks and is frequently found in passive income portfolios. The shares enjoy moderately stable growth, up 108% in the past decade. But more importantly, it pays a reliable dividend with a 5.8% yield.
Recently, it’s faced the risk of losses in its efforts to meet energy transition goals. This has been compounded by higher labour expenses as a result of the new UK Budget. If expenses get too high, it may have to cut its dividend to save capital for daily operations.
As a highly-established and critical utility provider, it’s likely to remain in high demand for decades to come. It also exhibits defensive qualities, typically performing well even through economic downturns.
There are many similar UK stocks with high yields and steady dividend growth on the FTSE 100. Some examples include Legal & General, British American Tobacco, and Tritax Big Box REIT.
By reinvesting dividends now and staying patient, I’m building towards a future where my investments pay me instead of the other way around. The road to financial freedom starts with smart choices today.
Editor Insights
Sub-scale funds leaving the market, not the only game in town in London’s investment co. space. If the no. of trusts in the FTSE100 is anything to go by, larger funds are going from strength to strength: Polar Capital Technology (PCT) and AllianceWitan (ALW), the latest to gain FTSE100 promotion. With multiple funds in the FTSE250 with multi-billion market caps, chances are they won’t be the last.
By Frank Buhagiar
The Great British Success Story label for investment companies is not referring to those halcyon days at the beginning of the decade when IPOs (Initial Public Offerings) of alternative funds investing in weird and wonderful assets such as battery energy storage projects, life sciences parks, hydrogen or even space were aplenty. Or even when Scottish Mortgage’s (SMT) share price could do no wrong and powered ever upwards – over the 10 years to 30 September 2021, SMT’s net asset value (NAV) per share increased by +1,072% versus a +275% increase in the FTSE All-World index (both in total return terms) according to the global fund’s interim management report of 08 November 2021.
No, Great British Success story refers to the here and now. That might seem somewhat out of kilter with what’s been going on in the sector these past few years. After all, not a week goes by it seems without a fund announcing plans to wind down, buy back shares, launch a tender, hold a continuation vote, cut its fees or introduce some other mechanism to tackle a gaping share price discount to net assets or to fend off the unwelcome attention of an activist investor. Fair to say a large number of these funds are on the small side, believed to be sub-scale and therefore not considered suitable by super-sized wealth managers, themselves the product of their own wave of corporate activity and consolidation.
Sub-scale funds winding up or being taken over is not the only story playing out in London’s investment company sector, however. Another is at work, one that is perhaps flying under the radar – growing representation of investment companies in London’s largest stock market indices, specifically the FTSE 100 and FTSE 250.
Take the FTSE 100. More and more funds are being promoted to the top-tier index. Polar Capital Technology (PCT), the latest to gain entry earlier this month. It’s been a relatively rapid rise for the trust. As per the Company’s press release of 3 February 2025 the fund was launched in 1996 as the Henderson Technology Trust. Management of the fund was transferred to Polar Capital in 2001. Five years later, current lead manager Ben Rogoff took over the reins. Under Rogoff and his team’s stewardship, the trust’s assets and market cap have grown to £4.6bn and £4.4bn respectively, enough to warrant inclusion in the FTSE 100.
And from the sounds of it, Rogoff sees more of the same going forwards “More than anything, our inclusion in the FTSE 100 Index reflects the extraordinary nature of technology, its ability to reinvent industries, create massive new markets and drive superior returns for investors. Technology has conquered distance, connected billions and democratised knowledge. Today, rapid innovation is propelling AI towards superhuman capability. While market fluctuations are inevitable, PCT is well positioned for the AI-era which we expect to be one of the most exciting and transformative investment opportunities of our lifetimes.”
PCT isn’t the only investment company to gain promotion to the FTSE 100 in recent months. October 2024, saw Alliance Witan (ALW) enter the index following the tie-up between two globals, Alliance and Witan, to create a £5bn plus fund. June 2024 saw LondonMetric Property (LMP) achieve the same feat after a run of acquisitions. There have been others too. The world’s oldest investment trust, F&C IT (FCIT), won promotion in September 2022. December 2020, it was the turn of Bill Ackman’s Pershing Square Holdings (PSH). A steady increase in the number of FTSE 100 investment trusts then. Today, if you include the three real estate investment trusts (REITs), there are no less than nine funds in the FTSE or to put it another way almost 10% of the UK’s number one index are investment companies:
FundMarket CapSector
3I Group (III)£39.5bn Private Equity
Alliance Witan (ALW)£5.2bn
GlobalBritish Land REIT (BLND)£3.7bnProperty
F&C (FCIT) £5.7bn
Global Land Securities (LAND)£4.3bn
PropertyLondonMetric (LMP)£3.9bn
PropertyPershing Square (PSH) £8.1bn
North AmericaPolar Capital Tech (PCT) £4.4bnTechnology
Scottish Mortgage (SMT)£13.6bn Global
And chances are, the number of investment companies in the FTSE 100 will continue to grow. That’s because there is a healthy smattering of funds with multi-billion-pound market caps in the FTSE 250 chomping at the heels of the smallest FTSE 100 companies.
There’s yet another property company, warehouse investor Tritax Big Box (BBOX), on a £3.7bn market cap. Then there is JPMorgan Global Growth & Income (JGGI) with a soon-to-be be increased £3bn market cap once its latest acquisition – Henderson International Income (HINT) – completes. If it does, that would be JGGI’s fourth acquisition in three years – JGGI single-handedly doing its bit to solve the sub-scale fund problem at the smaller end of the investment trust spectrum.
3I Infrastructure (3IN), not far behind with a £3bn market cap and that’s despite seeing its share price move from a -2.8% discount to net assets as recently as 1 August 2024 to -14% just six months later.
Petershill Partners (PHLL), another alternative fund on a £3bn-ish market cap. Shares in the Goldman Sachs-backed fund that pioneered investing in middle-market alternative asset managers were the second-best performer in the sector in 2024 with a +68.9% gain.
Flexible investor RIT Capital Partners (RCP) not far behind with its £2.7bn market cap. SMT’s stablemate Monks (MNKS) is next on £2.6bn before the first renewable Greencoat UK Wind (UKW) on £2.5bn, proving not all in the sector have the sub-scale tag.
Private equity fund, HgCapital (HGT) and infrastructure funds HICL Infrastructure (HICL) and International Public Partnerships (INPP) meanwhile all with market caps in the £2.2bn -2.3bn range.
And it’s not just alternatives, conventionals too among the largest in the FTSE 250 including City of London (CTY), JPMorgan American (JAM), Caledonian (CLDN) and Smithson (SSON), all on £2bn market caps.
There’s a whole host of names with market caps just shy of £2bn too – Allianz Technology (ATT), Mercantile (MRC), Renewables Infrastructure Group (TRIG), Templeton Emerging Markets (TEM), Murray International (MYI), Worldwide Healthcare (WWH) and Personal Assets (PNL).
Could go on, but point made – even in today’s challenging higher interest rate environment particularly for the alternatives, London is not short of large-scale investment companies. Some of these large scalers are growing with the help of acquisitions such as JGGI, others just on performance alone such as PCT.
And here’s the nub, with operating companies leaving London’s stock markets either through takeovers or going private or overseas, chances are investment company representation in the larger indices will increase in the years ahead. It’s not impossible that the investment company subsector then could one day be among the FTSE 100’s biggest. If that happens, then the Great British Success Story that is investment companies will no longer be flying under the radar but will be there for all to see.
Pick-up in results this week with no fewer than six funds in the latest round-up: Brown Advisory US Smaller Companies (BASC), Herald (HRI), BlackRock Throgmorton (THRG) , Polar Capital Global Financials (PCFT), City of London (CTY) and Rights & Issues (RIII). But which fund put in the best performance with a +34.8% NAV per share return for the year?
By Frank Buhagiar
BASC’s +5.3% net asset value (NAV) per share return for the half year, a tad off the Russell 2000’s +10.7%. Chairman Stephen White points out that much of the benchmark’s performance “was led by a narrow subgroup of more speculative or unprofitable stocks, many of which were driven by exuberance in the AI, quantum computing, and cryptocurrency sectors.” By contrast, the portfolio managers focused “on strong quality businesses and long-term compounders, that they believe will deliver truly sustainable growth, but which lagged the rally.” The portfolio managers provide examples of the Russell 2000’s “wild exuberance in certain niches”, including Rocket Lab, “a money consuming space company” which saw its share price jump +431% in the second half of 2024; and Rigetti Computing up a cool +1,326%.
White sees good times ahead, “recent developments have caused us to remain optimistic for the prospects of our portfolio. For developments read “The shift in monetary policy by the Fed in September and the first rate cuts since 2020, combined with Donald Trump’s ‘clean sweep’ presidential win and a perceived more business-friendly administration,” all of which “should be supportive for smaller companies with a more domestic bias.” And it’s not just wishful thinking it seems, as “relative performance has picked up since the half-year end.”
Winterflood: “During the period, the average weighting to Financials was c.5%, compared to the Russell 2000 Index weight of nearly 18%. The financials sector rose over 20% during this period, negatively impacting performance by c.1%.”
Herald’s (HRI) double-digit full-year return
HRI’s strong performance track record, specifically the +2,611.1% NAV per share total return since inception in February 1994, a key highlight in the fund’s full-year results. The latest numbers weren’t bad either: NAV per share total return came in at +12.1%. Easy to see why shareholders rejected the advances of activist investor Saba Capital at the recent general meeting. As for this year’s main drivers, the North America segment of the portfolio, the star of the show with a +36.3% return thanks to the AI-led tech boom. The US more than made up for a more pedestrian showing by the UK holdings which were up +3.3% – HRI’s UK stocks were held back by the weak performance of the AIM market.
Investment manager Katie Potts believes “There are a number of factors that should drive continued growth in the wider technology sector.” Artificial intelligence is one. So too, the drive to net zero which “poses some unresolved technical challenges, in particular the storage and distribution of renewable power”. Meanwhile “a geopolitically volatile world” is driving “innovation in defence and cyber security.” Opportunities abound then. But as Potts notes, after the battle with Saba “The challenge for the Company is to unite shareholders around its mandate in order that we can continue to make long-term investments in smaller quoted technology companies.” The continuation vote due to be held in March will provide an early test of that unity and also of Saba’s intentions.
Numis: “If shareholders again show support for Herald’s existing strategy and the continuation vote passes, the board will still likely need to engineer a way to facilitate an exit for Saba to remove the overhang of shares, whilst being fair to the remaining investors – which can be a difficult balance.”
BlackRock Throgmorton (THRG) outperforms during unusual year
THRG comfortably outperformed the Deutsche Numis Smaller Companies plus AIM (excluding Investment Companies) Index over the full year: NAV total return of +16.3%, +2.2% above the benchmark. Chairman Christopher Samuel describes the outcome as “a pleasing result for a cautiously positioned portfolio in a challenging and unusual year.” Portfolio manager Dan Whitestone has now beaten the benchmark in 9 of the last 10 years with the fund’s +130.5% NAV total return between March 2015 and 30 November 2024 not far off three times the benchmark’s +51.8%.
Whitestone admits “2024 has been one of the most difficult years to navigate”, citing outflows in the asset class and mergers and acquisitions in the UK small and mid-cap space as private equity and overseas buyers capitalised on depressed valuations and a weak currency. Thing is, “This is only good news if you own the shares.” Whitestone is finding it “hard to get too constructive on the UK small and midcap universe right now, given the domestic fiscal environment.” Having said that “a deep recession is unlikely, but our hopes for a V shaped recovery in 2025 have been squashed. Our base case now is a return to the environment of 2023, subdued demand and anaemic growth.” What to do? “Continue to invest in companies with strong balance sheets, and growing cash flows.”
Numis: “We rate the manager, Dan Whitestone, highly. The fund has a ‘quality growth’ bias, with a focus on businesses with favourable competitive positions, organic revenue growth and strong balance sheets, looking for companies with a compelling runway for growth and an asymmetric risk/ reward opportunity.”
Polar Capital Global Financials’ (PCFT) best annual investment performance
PCFT’s +34.8% NAV per share return, the best annual investment performance in the fund’s history according to Chairman Simon Cordery. The full-year performance, a tad below the benchmark’s +36.1% but strip out the 6.5% of the portfolio that is invested in fixed income securities which ‘only’ returned +12% and the investment return would have beaten the all-equity benchmark. As the investment managers point out, those stellar fund and benchmark performances down to financials being “the best performing sector of the global equity markets in the period, beating information technology into second place.” Longer-term investment performance stacks up too: NAV total return since PCFT’s reconstruction in April 2020 to 30 November 2024 stands at +129.9% compared to the benchmark’s +128.1%.
The investment managers think there could be more to come “We remain confident on the outlook for the financials sector.” The confidence is based on their view that “the investment background has fundamentally changed from the challenges of the last decade. Interest rates are ‘normalising’ and there is demand for significant investment in reshoring, defence and decarbonisation. We believe the sector will be a key beneficiary of these trends.”
Numis: “Exposure is broader than traditional banks, including exposure to payment systems and insurers and the managers are not afraid to actively manage positioning dependent upon changing market conditions. The shares currently trade on a tight discount of c.4%, which we believe largely reflects the upcoming tender offer for up to 100% of share capital at NAV less costs.”
City of London (CTY) being paid to hold on
CTY maintained its record of outperformance during the latest half year: +2.8% NAV total return versus +2.7% for the AIC UK Equity Income Sector and +1.9% for FTSE All-Share. That means CTY has now outperformed over six months, one, three and five years. Over 10 years, the +83.8% NAV total return beats the All-Share’s +81.9% but falls short of the sector’s +88.9%. Not quite a full house but close. As for what’s behind the outperformance this time round, stock and sector selection cited.
In his outlook statement Chairman Sir Laurie Magnus CBE points out that while CTY invests in UK stocks “At 31 December 2024, some 63% of the underlying sales of investee companies were made overseas. They are therefore well placed to benefit from global growth trends.” What’s more “Given the relative attraction of UK equities to their equivalents in overseas markets, especially with regard to dividend yield, it remains the case that investors in UK equities ‘are paid to hold on’. Unless of course buyers take advantage of the low valuations on offer “More takeovers can be expected from overseas companies and private equity firms while this low relative value of UK equities persists.”
Winterflood: “Share price TR +5.1%, as discount narrowed to 0.0% from -2.2%. Board is confident of 59th consecutive annual dividend increase. Ongoing charges expected to remain around 0.37% for FY25.”
Rights & Issues (RIII) sees opportunities and challenges
RIII’s +8.8% NAV per share return for the full year easily beat the FTSE All-Share’s +5.5%. Good start then for new lead manager Matt Cable who took over at the half-year stage. Looking ahead, Chairman Dr Andrew J Hosty “expects to see continued volatility in the markets. So, whilst there are some signs that energy prices, inflation and interest rates may have peaked, we are now seeing rising gilt yields and, in the UK where we focus, higher employment taxes to contend with.” All of which will generate “opportunities as well as challenges.” Expect no change then in the strategy to seek “investments in differentiated companies operated by good management teams that they believe to be fundamentally underpriced.”
Winteflood: “Share price TR +11.7%, as discount narrowed to 6.4% from 8.9%. Board considered share split to improve liquidity, but decided not to pursue following shareholder feedback.”
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Currently xd for 2.11p per share payable on the 31 March
Yielding 12.6% trading at a discount to NAV of 32%
The most important thing to check is how secure is their dividend, although it could still fall or not be increased it would still be a high yielding Trust.
Remember it’s only a fcast but a positive fcast is better than a negative fcast.
What does the company say about it’s dividend.
Dividend:
· The Board is pleased to reaffirm its full-year dividend target guidance of 8.43p per Ordinary Share for the financial year ending 31 March 2025.
· The full-year dividend target per Ordinary Share is forecast to be covered in a range of 1.1x – 1.3x by earnings post-debt amortisation.
· Total Ordinary Share dividends paid since IPO of £346m.
· As at 19 February 2025, the Company offers an attractive dividend yield of c.12%.
The paid dividend is covered, so until news it’s looks secure.
Let’s work on a flat dividend for the next ten years.
You would have received all your capital back and achieved the holy grail of investing of having a share in your portfolio that pays you a quarterly income at a cost of zero, zilch nothing.
U could also re-invest the dividends in another High Yielding Trust that would pay u an income, although over ten years the percentage u could re-invest at is the unknown but there is normally one or two unloved sectors to re-invest in.
You simply need to monitor the declared dividends and the company’s guidance on any future dividends. The price of the share in ten years time is of no consideration as the intention is never to sell but use the income as an ‘annuity’.
The worst possible scenario is, if they don’t cut the dividend would be the Trust to be taken over but with the discount u would most probably print a profit.
This case study is not a recommendation to buy.
NESF is in the current Snowball but there is no intention to add to this position at this moment in time.
Story by James Beard
Passive and Active: text from letters of the wooden alphabet on a green chalk board© Provided by The Motley Fool
High dividend yields need to be treated with caution. On paper, they could be excellent for passive income. But sometimes they’re too good to be true.
Let’s explore this by doing some maths
An investment of £10,000 in a stock yielding 16.5%, would generate dividends of £1,650 in year one. Assuming the amount received was reinvested, income of £1,922 would be earned in the second year. Repeat this for another 18 years — a process known as compounding — and the investment pot will have grown to £212,089. At this point, the company will be paying annual dividends of £34,995.
This shows that, in theory, it’s possible to take a relatively modest lump sum and use it to generate a very healthy level of passive income. Yes, it’ll take a couple of decades but as they say, Rome wasn’t built in a day.
Is this really possible?
While such high returns are unusual, they do exist.
For example, based on the dividends it’s paid over the past 12 months, Liontrust Asset Management (LSE:LIO) is currently yielding 16.5%.
However, like most shares offering a double-digit yield, this figure needs to be treated with caution.
For the past three financial years, the specialist fund manager has maintained its dividend at 72p a share. Indeed, it looks as though this run will be extended to a fourth, when its results for the year ending 31 March 2025 (FY25) are declared.
However, the generous yield indicates a problem that’s been around for a while now. Namely, that the company’s share price keeps falling. Since its peak in September 2021, it’s down 81%.
And this fall has boosted the yield. At the end of FY22, it was 5.6%. As the stock price continued to fall – and the dividend remained unchanged – the return soared. It was 7% at the end of FY23, and 10.7%, a year later.
Buyer beware
This is a good example of why shares apparently promising high levels of passive income need to be treated with caution.
And in my opinion, the reason why Liontrust’s value is declining is because its assets under management (AuM) are getting smaller.
The company makes money by managing funds on behalf of its clients. But as the table below shows, its AuM have fallen during each of its last four accounting periods. If the funds acquired from buying other companies are removed, the position looks even worse.
And if this trend persists, I think it’s inevitable that the dividend will be cut.
However, the company’s chair appears to interpret events differently to me. He confidently asserts: “The underlying business is in better health than it has ever been with regards to investment proposition, quality of people, reach of sales and marketing, and strengthening business infrastructure.”
If challenged, no doubt he’ll point out that the company’s profitable — it reported earnings per share of 13.67p for the first six months of FY25. But with this level of performance, it remains a puzzle to me how a dividend of 72p can be maintained. And I fear if it’s cut, there’ll be a major knock-on effect on the company’s share price.
For this reason, I don’t want to invest, despite the attractive dividend on offer.
The post Could this 16.5%-yielder turn £10,000 into annual passive income of £34,995? appeared first on The Motley Fool UK.
There are plenty of other trusts which pay a dividend from capital spread across all the major equity sectors. JPM has a whole suite of funds from Asia to Europe and the UK with an enhanced dividend, all of which have a growth-heavy investment approach.
In fact, in AAIF’s own sector, there are now three trusts with an enhanced yield: AAIF, JPMorgan Asia Growth & Income and Invesco Asia Trust (IAT). Interestingly, AAIF has seen its discount move in from being the widest in the sector to being in line with these other two trusts, which have discounts between 10 per cent and 11 per cent. Schroder Oriental income (SOI) is trading on a much narrower discount of 7.1 per cent, but has a lower yield and does not pay out of capital, with the income being purely ‘natural’. I think the crucial factor here is size: SOI has a market cap of around £650m while the others are all below £300m.
With IAT soon to complete a combination with Asia Dragon that will more than double its size, it may be that this is a catalyst for the discount to narrow, as a broader pool of professional investors can consider it.
One of the additional secrets behind JGGI’s success may be its size, which means it can be invested in by wealth managers and institutions which need to own large blocks of shares as well as retail investors.
Paying from capital hasn’t always been possible, but regulations have changed over the years. One of the pioneers of this approach was European Assets Trust (EAT), which adopted it in 2001. The trust pays 6 per cent of the closing NAV of the previous financial year in dividends, and the historical yield is 6.6 per cent at the time of writing.
The portfolio is invested in European smaller companies, not typically a great source of dividends, but a market with great growth potential. I think like IBT this is a slumbering growth market which should produce great returns at some point in the future when the market environment shifts.
Not everyone approves of this sort of policy, although perhaps fewer people object each year as it becomes more established.
Sometimes people object that it is not really a dividend at all but just drawing down from capital. Imagine you had a cash account of £10,000 which paid you 5 per cent a year in interest, and you took out 6 per cent each year. Then you would be drawing down your capital. But in the case of equities, they go up over the medium term.
Now, nothing in finance is as certain as a law of physics, but there are all sorts of reasons to think this will continue to be the case. So we should expect to see any growth in an equity portfolio more than offset any contribution from capital to the dividend, assuming the board have struck the right balance and not committed to a truly excessive contributions from capital.
And crucially, it is always possible for the end investor to reinvest their dividends, in which case this isn’t a concern at all.
People sometimes choose to focus on the effect in a falling market. If the NAV is falling, and the trust makes a contribution from capital to the dividend, then the portfolio value will fall by more than the market. This is true, but over a medium to long-term investment horizon, we should expect the market to rise, and again, investors can simply choose to reinvest their dividends.
There is a short-term negative effect from this dynamic though: if the capital paid out is higher than the income earned, the fund will shrink and so costs will be higher for remaining shareholders. But funds without an enhanced dividend will also be shrinking when this happens thank so the falling market, and their costs rising too, so what we are really talking about is slightly magnifying this risk we take by investing in pretty much all funds.
One issue you do have to watch out for with these strategies is the variability of the dividends. Paying from capital typically involves paying a fixed amount of NAV each year. Dividends therefore change as the NAV does, which means that if the NAV falls, next year, or next quarter, depending on the exact policy, the dividend might be lower.
Some investors might not like the irregularity this brings. Investment trusts can use revenue reserves to smooth dividends and provide very reliable payments. There are at least 51 trusts which have maintained or held their dividends for at least 10 years, largely due to the ability to build up reserves for when income falls.
During the pandemic, when dividends were cancelled by many companies, almost all equity income trusts were able to maintain their distributions to investors, unlike open-ended funds which have to pay out all income earned.
Buying a trust with an enhanced dividend might, therefore, mean accepting less regularity in the income stream received. Any effect of this could be moderated by owning other trusts with a natural income stream, high revenue reserves and an obvious commitment by the board to maintaining the dividend.
Investors don’t seem to mind this feature, judging by the generally positive impact on the discount an enhanced dividend has had.
Where things have come unstuck though, is when boards have changed the policy too often. This was a major problem for Invesco Perpetual UK Smaller Companies (IPU).
The trust paid 4 per cent of NAV, like many others discussed, with a big contribution from capital.
During the pandemic, presumably nervous about the drop in portfolio income – and maybe listening to the critical voices about the impact of this policy in a falling market – the board slashed its dividend target to 2 per cent of NAV, leading to the share price plunging.
Despite reverting to the 4 per cent target later on, the trust has never regained the very narrow discount it used to enjoy pre-pandemic.
I think the lesson is that investors are comfortable with enhanced, or manufactured yields, and they are comfortable with the variability from quarter to quarter, but they want a consistent policy over the medium to long term they can use to help build a portfolio.
Investors have been sucked back into bonds in recent weeks, looking to take advantage of a spike in yields early in January. Eventually, they will time this right, although the last few years have seen expectations for interest rate cuts, which would see bond prices rise, pushed back and watered down again and again and again.
With UK equity valuations being low, yields are also pretty high in that market too, with greater potential for price appreciation if rates stay higher for longer.
There are high dividend ETFs out there with decent yields, the iShares UK Dividend ETF having a trailing yield of 5.6 per cent at the time of writing. But I think when it comes to income, the advantages of investment trusts means that passive is a poor option.
High yields can be earned from all sorts of underlying growth markets, some of which are supported by bulletproof revenue reserves and some of which are raised well above the yields on bonds or ETFs thanks to the use of enhanced dividends.
All in all, it’s never been a better time to use investment trusts for income.
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