Is Scottish Mortgage’s ‘dividend hero’ status under threat?

Scottish Mortgage has increased dividends for 34 straight years, but may have to draw on capital to continue

In 1909 Scottish Mortgage (SMT) was established on a simple premise – to buy global shares – and today it is still following its original brief in aiming to maximise its total return to its shareholders over the long term.

The focus is very much on the ‘growth’ style of investing, but something that shareholders have become accustomed to over the years is its annual dividend payment. SMT has a formidable record on this front, having increased dividends for 34 consecutive years.

Looking further ahead, however, there are question marks over whether SMT will remain a ‘dividend hero’, due to the fact that the two managers at the helm of the trust – James Anderson and Tom Slater – have over the years been increasingly buying businesses built on cutting-edge technology, the likes of Alphabet (Google), Facebook and Alibaba, China's biggest online retailer.

These types of businesses don’t pay dividends and are instead more focused on growing their market shares, either organically or through acquisition. This goes some way to explain why SMT’s overall dividend yield remains low, at 0.7 per cent.

Therefore, to ensure that enough money is left in the dividend till each year to fund the annual increases, SMT may need to dip into its revenue reserves, a point the board stressed last week as the trust reported its half yearly results. Furthermore, the board may also have to chip away at capital to continue satisfying income-hungry shareholders.

‘Without a sizeable increase in the income received from the portfolio in the second half of the financial year, come 31 March 2018 the board will face a choice either to cut the dividend, or to continue to pay a comparable dividend supplemented from capital profits and the remainder of the revenue reserve,’ the report said. 

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‘Currently, no such significant increase in revenue is anticipated. As the company’s stated objective contains an explicit dividend growth component, the board wishes to reiterate to shareholders that it would be willing to consider funding a dividend payment in part from capital profits, provided that the board is of the view that the total returns being earned by the company over the long run justify this.’ 

The board adds it will review the position again at the end of the financial year. As things stand today the board has proposed to pay an interim dividend of 1.39p, which is unchanged from the same period last year.

Is your trust delivering income by eating away at capital?

If SMT does resort to eating away at capital it will join a growing number of investment trusts that have moved to boost their dividend payments this way. According to the Association of Investment Companies (AIC), since a change to tax rules five years ago opened the door for onshore investment trusts to pay dividends this way, there are now 22 investment trusts that fund dividends out of capital or have stated their intention to do so in the future.

The AIC, which over the past couple of months has beefed up its dividend data information for investors, now details on its website how dividends are paid, as well as each trust’s dividend history, amount held in revenue reserve and the trust’s dividend cover score.

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Notable equity trusts that fund distributions from capital include: European Assets, Personal Assets, RIT Capital Partners, Securities Trust of Scotland and Invesco Perpetual UK Smaller Companies.

Turning capital into income may come at a cost, as over time it risks reducing the long-term net asset value growth (NAV) of the trust, which in turn will stunt dividend growth. Most trusts, however, will have the flexibility to draw on their revenue reserves to keep dividend growth flowing.   

Simon Elliott, of Winterflood, the broker, acknowledges that some commentators have been critical of trusts dipping into capital, but in his view it is ‘another advantage that the closed-ended fund structure provides.’

He adds: ‘The ability to use revenue reserves to provide greater dividend certainty is well-established and appreciated by the market. It has allowed a number of investment trusts to develop impressive records of year-on-year dividend growth. The ability to convert capital into income takes this a stage further and allows funds investing in low or non-yielding assets the opportunity to pay regular dividends.’

Boards that have moved to enhance their dividend payments are essentially putting themselves in the shop window for investors seeking higher returns against the continued backdrop of record low interest rates.

Nigel Wightman, chairman of JPMorgan Global Growth & Income, which last July tweaked its distribution policy to return 4 per cent of NAV to shareholders each year on a quarterly basis, says the trust ‘has a role to play in easing the burden of an ultra-low interest rate world.’

‘This policy seems to have been well received with renewed interest in the company’s shares,’ he says. ‘While the investment outlook is unquestionably mixed, the board believes the manager’s robust investment process and extensive internal research resources, which remain unchanged following the revised distribution policy, will continue to be able to identify attractively priced high-quality companies in which to invest for our shareholders.’  

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