New analysis has revealed the size of UK equity income investment trusts’ ‘rainy day’ reserve funds, which can be dipped into in order to retain or increase dividends.
Income-paying investment trusts have a particular attraction for investors who want a regular cash flow, due to the fact that unlike open-ended funds they do not have to distribute all the income generated by their assets every year.
They can hold back up to 15% each year, which means they can build up a “rainy day” fund (known as revenue reserves) to bolster dividend payouts in leaner years or during more challenging times, such as now.
This advantage also helps soften some of the blow of the relatively large losses incurred by some investment trusts during the market sell-off as a result of their ability to borrow, or gear. Gearing in a rising market magnifies gains for each shareholder; but if the market falls, investors in a geared trust will suffer larger losses per share.
In the current period of uncertainty, the key question investors will no doubt want answered is whether the rainy day funds are sufficiently big enough to accommodate the dividend drought that is expected to materialise in the coming months. This could potentially rumble on until the end of 2020 as various firms suspend, cut or completely remove dividend payments.
While no one can pre-empt the decisions that will be made by investment trust boards as to whether to cut, maintain or increase their dividend payments, the good news is that UK equity income trusts are in a healthy position to continue to satisfy income-hungry shareholders.
Analysis by the investment companies team at Investec Securities found that all 17 investment trusts that it analysed (although there are 24 in the sector as a whole) would be able to endure a 30% fall in dividend income from their underlying holdings over the next year, and still pay a progressive dividend (it modelled a 3% rise). The 30% figure was used because this is the dividend decline that is being priced in by the futures market.
Alan Brierley, an investment trust analyst at Investec Securities, says: “Although the dividends would be uncovered, the revenue reserves would be sufficient to cover the resultant shortfall. In most cases, the revenue reserve would remain reasonably healthy.
“Our first scenario assumes a brutal few months but then a strong economic recovery fuelled by unprecedented liquidity now being injected into the global economy, and critically the coronavirus under control.”
Further analysis was carried out for year two, with another 30% fall in income and another dividend rise of 3%. Under this scenario, it found, the revenue reserves of eight investment trusts would still be sufficient to cover the shortfall of income that was not being generated by the portfolio’s underlying holdings.
The eight investment trusts are: Aberdeen Standard Equity Income, BMO Capital & Income, Dunedin Income Growth, Edinburgh Investment, Finsbury Growth & Income, JPMorgan Claverhouse, Law Debenture Corporation, Schroder Income Growth.
The table below, sourced from Investec Securities, ranks the revenue reserves at the end of the last financial year of each company. The reserves are expressed in terms of the number of months the total dividend paid in the last financial year could be covered in full.
|Investment trust||Revenue reserves (in months)|
|Law Debenture Corporation||15.4|
|Schroder Income Growth||12.1|
|BMO Capital & Income||11.5|
|Aberdeen Standard Equity Income||10.5|
|Finsbury Growth & Income||9.9|
|Murray Income Trust||9.8|
|Invesco Income Growth||8.9|
|Diverse Income Trust||8|
|City of London||6.9|
|Perpetual Income & Growth||6.8|
|Troy Income & Growth||5.6|
Source: Investec Securities
Another investment trust analyst, Winterflood, agrees most UK equity income investment trusts are “well-placed to continue to support their existing dividend levels.”
But it adds: “We would counsel caution. Revenue reserves have historically proven effective in supporting dividends when there has been a shortfall, particularly in the aftermath of the global financial crisis and then in 2010 when BP suspended its dividend.
“However, there is the possibility this time that a large proportion of the equity market sees dividend suspensions, as companies seek to preserve their cash and reduce pressure on their balance sheets at a time when revenues may be significantly disrupted.”
Winterflood adds that this puts the boards of income-focused investment trusts in a difficult position in deciding whether to use revenue reserves or cut their dividends. “In our opinion, this comes down to a judgement as to the likely length of the disruption as well as the extent of the revenue shortfall in the short term.
“If the disruption is relatively brief, investment trusts should be well-placed to sustain dividend levels for a three- or six-month period. However, the gamble is that we could be in a prolonged period of lower revenue.”