Investment trusts paid record dividends to their shareholders in the twelve months to the end of March according to the latest Investment Trust Dividend Monitor, a special supplement of Link Group’s UK Dividend Monitor. Between them trusts paid out £5.5bn, up 15.4% year on year.
Trusts that invest only in listed equities held payouts exactly steady at £1.85bn. These trusts distribute the dividends they receive from companies listed on stock exchanges in the UK and around the world so they were impacted by the cut in global payouts, and the even more severe one in the UK, that accompanied the first year of the pandemic. Even so, the peak-to-trough decline in dividends from equity investment trusts was only 1.9% as trusts dipped into reserves and took advantage of special rules that permit them to distribute some of their realised capital gains.
The use of reserves continued in the second half of 2021 but at a much-reduced rate. Reserves have been needed while the pool of dividend income that funds investment trust dividends itself continues to recover.
The first quarter of 2022 saw dividends from equity investment trusts 4.0% higher than the first quarter of 2021 (when they reached their nadir), a total of £437m.
Over the next twelve months, Link Group expects dividends from these categories of investment trusts to rise 4% to a total of £1.92bn. This is slower than either expected dividend growth in the UK or globally, but reflects the fact that investment trust payouts were shielded from wider dividend cuts in 2020/2021 and trusts are now rebuilding reserves.
Rapid dividend growth in the last year came from alternative investments, not traditional equities
The rapid increase in payouts was driven not by these ‘traditional’ investment trusts, but by those that invest in alternative assets, whose payouts collectively rose 25.1% to £3.65bn.
The biggest increase came from Venture Capital Trusts (VCTs). VCTs handed out £556m between April 2021 and March 2022, up 65.7%, while renewable energy infrastructure funds paid their shareholders £583m, up 38.3%. Along with property, the largest dividend-paying sector in the alternatives segment, these categories accounted for four fifths of the overall increase in dividends from all kinds of investment trusts in the twelve months to the end of March 2022.
In 2010, alternative categories of investment trusts contributed less than a third of the dividends paid by the sector overall. In 2021 they contributed two thirds. Their payouts were nine times larger in 2021 than in 2010.
Ian Stokes, Managing Director, Corporate Markets UK and Europe said: “10 years ago, alternatives were a much smaller segment of the investment trust market, but they have rapidly expanded as new investment opportunities have opened up in response to investor demand. Given that many of the assets in alternatives trusts are relatively illiquid, they are very well suited to the closed-ended structure.
“VCTs have proved very popular with investors in recent years who have been attracted by the generous tax breaks. A reduction in the lifetime allowance on pension funds is catching more and more savers with punitive tax on their pension pots. The measure has deterred pension saving among wealthier individuals who have looked elsewhere for tax-efficient options for their capital. With a 30% tax credit on capital subscribed in a VCT share issue and all income and capital gains tax free, VCTs are the first port of call for many investors now. VCTs have been very big issuers of shares in recent years as a result.
Ian Stokes concluded “Investment trusts are an interesting proposition for investors. First, they are able to invest almost anywhere in the world. Secondly, they can invest in different asset classes beyond just listed equities, enabling access to hard-to-reach opportunities like private equity or venture capital.
Thirdly they are able to borrow modestly, using debt to buy more underlying assets, thereby enhancing returns to shareholders over the long term (this is known as gearing). And finally, many of them have reserves that they can draw on in bad times to cushion their shareholders when dividends from the companies they invest in go down.”
Richard Stone, Chief Executive of the Association of Investment Companies (AIC), said: “This report demonstrates that investment companies offer an abundance of benefits to income investors and have continued to do so through challenging market conditions.
“Many investment companies have a long track record of delivering dividends through crises and this has proved true during the Covid pandemic. Investment companies are able to hold back some of the income they receive from their portfolios and use these reserves to maintain dividends when times are tougher. This helps explain why there are seven investment companies that have increased their dividends each year for 50 years or more, and 17 in total that have increased their dividends every year for over 20 years – known as the dividend heroes.
“Investment companies are also highly suitable for investing in alternative assets which can generate attractive yields, like renewable energy infrastructure, property and debt. This is because they have a permanent capital structure and are listed on the stock exchange, allowing investors to buy and sell their shares easily. Meanwhile, managers can take a long-term view of their portfolio and be fully invested without ever being forced to sell.
“In the current inflationary environment, some alternative assets like infrastructure and certain types of property deliver income which is contractually linked to inflation providing some comfort to income seekers when the cost of living is high.
“Investment companies also have independent boards of directors who look after shareholders’ interests, another important feature in tough market conditions.”