Dividends

Which is more attractive, a dividend based on a percentage of NAV or one paid out of revenue per share ?

I think the two can co-exist quite happily and help an investor build a more diversified portfolio. One of the key challenges for traditional equity income investors is the limited number of companies and countries one can invest in to get a relatively high dividend. The UK equity income investment trust sector has built up an enviable record of increasing dividends every year, but make no mistake, without the ability to use revenue reserves, that track record would not look quite so unblemished as there have been times over the years when the main dividend paying companies in the UK have not been able to increase dividends. Revenue reserves aren’t, by the way, a bank account where dividends from previous years are safely held but are just an accounting construct. The revenue reserve is invested as part of the net asset value and when a trust uses its reserves, it comes off the net asset value in just the same way as a dividend paid as a percentage of NAV does. So, while they may be called different things, they aren’t so different in terms of their effect on the end investor.

The big advantage of traditional equity income trusts is that they focus on a progressive dividend, i.e. one that increases each year regardless of where the NAV has gone. Anyone investing to use the income to live off will obviously be drawn to this as their income hopefully rises with inflation. Further, the types of companies that pay dividends could be considered more conservative businesses less likely to give investors unpleasant surprises. There have been times though when this is very much not the case, with the financial crisis being the big example, and so it seems sensible that any income investor should consider some diversification. This is where trusts that pay dividends from capital may have a role to play, as these trusts more often than not invest in different companies and markets.

I’d go one step further and say that with average life expectancy being so long past retirement, investors may have the opportunity to continue to target more growth-orientated strategies in their portfolio. Trusts that offer dividends paid from capital very often have more growth-orientated strategies but offer investors a convenient way to draw some income at the same time. Of course, the main difference is that the dividend will rise and fall with the NAV and investors will need to think about how much tolerance they have for that within an overall portfolio.

Kepler