However, looking at one data point is just a snapshot and can be easily affected by specifics. Therefore, to assess the change in the market’s judgement over time, we have looked at several examples of strategies that have adopted these policies and studied what has happened to their discounts in the period before and after the announcement of a new policy.

One of the most recent adopters of this policy has been JUGI. This trust is the result of a combination between the firm’s UK small-cap and mid-cap trusts in the first quarter of 2024. As part of this corporate activity, a new enhanced dividend policy was announced that sees the trust pay c. 4% of NAV per annum in four equal payments. This began in August 2024.
In the chart below, we have shown how the discount of JUGI has changed in the year leading up to the announcement on 14/11/2023 and the period since. Following the completion of the corporate activity, JUGI’s discount has narrowed significantly, leading the trust to trade at a notable premium to the sector average, and close to NAV for the first time since the market highs of 2021. In the year before the announcement, JUGI (at the time, JMI) traded at an average discount of 12.1%, at an average 0.4% discount to the peer group. In the period since, the average discount has narrowed to 8.3%, which is an average 2.7% premium to the peer group.

JUGI: DISCOUNT VERSUS SECTOR

Source: Morningstar

This has arguably come at a fortuitous time for JUGI. The enhanced dividend policy was one of a series of announcements as part of the combination, which brought benefits such as better liquidity and lower charges. It has also coincided with a period of strong performance for the trust, following a rare period of weakness as the managers’ investment style fell out of favour. However, whilst it may have coincided with a number of positive factors, the discount has narrowed following the announcement and implementation of an enhanced dividend policy.

Looking further back, we have also looked at the history of abrdn Asia Focus (AAS), an Asian smaller companies trust managed by the three-strong team of Flavia Cheong, Gabriel Sacks, and Xin-Yao Ng. The board introduced an enhanced dividend policy in 2021 to provide a higher yield to investors from an asset class not typically associated with high income. The trust already had a strong history of either maintaining or increasing its ordinary dividend, having done so every year since 1998, as well as regularly paying out special dividends. For the 2024 financial year, the trust has paid out 7.42p per share, equivalent to a yield of 2.6% based on the share price as of 30/10/2024. This is an 18% premium to the most recent published yield of the trust’s benchmark, as well as the wider MSCI ACWI Small Cap Index which yields 2.1%.

In the year leading up to the announcement of the dividend policy on 30/11/2021, AAS had an average discount of 11.6%. This was at an average discount to the sector average of 2.5%. In the year following the announcement, AAS’s average discount was actually wider at 12.6%, though this was closer to the sector average at -1.2%. This suggests that whilst the enhanced discount policy did not lead to the trust trading at a narrower discount in absolute terms, it may have improved the trust’s rating versus its peers.

AAS: DISCOUNT VERSUS SECTOR

Source: Morningstar

To see if this has had a similar effect over a longer time period, we have looked at the discount history of two trusts that have had enhanced dividend policies for many years and analysed how their discounts have fared versus peers. Firstly, there is Montanaro UK Smaller Companies (MTU). This trust adopted a quarterly dividend equal to 1% of NAV in 2018, with the explicit goal of trying to increase the appeal to retail investors and therefore narrowing the discount.

Here, the impact is very stark. In the ten years before the enhanced dividend policy was declared on 25/07/2018, MTU traded at an average discount to the peer group of 4.3%, but in the six-plus years since, this has narrowed significantly, with the average discount since just 0.1%. In fact, the trust traded at a premium to the sector for much of the period, including several periods where this premium was in the double digits relative to the sector. More recently, some short-term weakness in the share price has meant the trust’s rating is currently trading in line with peers, which we would argue could be seen as an opportunity. Furthermore, as is the case with many trusts using an enhanced dividend policy based on NAV, it means the yield investors may receive is actually a little higher than the headline rate because of the discount. Whilst MTU pays a dividend equivalent to 1% of NAV per quarter, the current historic yield is 4.6% due to the trust’s double-digit discount.

MTU: DISCOUNT VERSUS SECTOR

Source: Morningstar

Our final example is EAT. As the pioneer of the approach, this trust has the longest track record available. The trust first started paying dividends from capital in 2001, which was allowed due to its dual listing in London and the Netherlands. At the time, HMRC had a rule against paying dividends from capital reserves, though this was removed in 2012, opening up the strategy to others. EAT’s management team primarily focus on mid- and small-cap European equities, though the dividend policy is to pay annual dividends of 6% of the closing NAV of the preceding financial year in four equal payments. This headline rate is nearly double that of the index at 3.1% as of 30/09/2024 and vastly ahead of its peers which range from 2.83% to 0.78% according to Morningstar.

We have shown EAT’s discount track record going back to May 2008 in the chart below. This shows that the trust’s discount has traded at a premium to the sector average for almost the entire time. Only a short period in late 2020, soon after the COVID vaccine was announced, did the sector trade at an average discount narrower than EAT. We believe this is a strong indication that enhanced dividend policies do have a positive effect on narrowing discounts. This is particularly impactful in the European smaller companies sector as there are no other trusts operating a similar approach, meaning EAT is a clear differentiator in this regard. That said, we note that EAT has slipped to a wider discount than the peer group in the past few months. This is one of the longest sustained periods of relative weakness in the past 16 years. Whilst this arguably reflects some performance headwinds, it could be seen as an opportunity for long-term investors, especially as it has pushed up the historic yield to over 7%.

EAT: DISCOUNT VERSUS SECTOR

Source: Morningstar

Conclusion

The practice of boosting the natural yield of a portfolio by paying dividends from capital is a clear demonstration of the flexibility and benefits of the investment trust structure. It increases the appeal of several asset classes to a wider range of investors and can make for useful tools for blending uncorrelated income streams as part of a wider portfolio.

Furthermore, over the long term, as we have shown it can prove useful in helping narrow a trust’s discount, especially versus peers, although it is not enough on its own to prevent wider macro factors affecting a trust’s discount. However, the wide discounts seen across the investment trust sector at present mean that the yields on offer look even more attractive due to many of them being calculated on a trust’s NAV. Moreover, the challenges seen in the wider economy have meant that many trusts are trading at wide discounts and several trusts with enhanced dividend policies are not trading at the premium rating they historically have done. This arguably creates an opportunity for long-term investors. With interest rates beginning to come down, those on a wider discount could soon benefit from improved optimism, whilst their elevated and reliable yields will only look more attractive on a relative basis.

Kepler