Investment trusts can bring security in retirement

INVESTMENT trusts that consistently deliver an income are set to enjoy a fresh surge in popularity under the pension “freedoms” taking effect in a month’s time.

Retirees seeking a reliable income from their pension pots are expected to turn in growing numbers to the funds, awareness of which has increased over the past two years.

The amount of money going into investment trusts has risen since the retail distribution review, which came into force at the end of 2012 and included a ban on commission payments from providers to advisers. Investment trusts didn’t pay commission and so often lost out to unit trusts and open-ended investment companies that did.

Legislation being introduced in April giving people more freedom with their pension pots is likely to further boost the sector as retirees look for new reliable income sources.

While there are drawbacks to investment trusts and many will be too risky for some older savers, their record of consistently paying inflation-beating dividends is a powerful lure for retired investors.

Ten different investment trusts have now recorded more than 40 years of consecutive dividend increases, according to the latest “dividend heroes” report from the Association of Investment Companies (AIC). Five more have notched up more than 30 successive years of increases.

Among them are some of Scotland’s oldest and best known investment names, including Dundee-based Alliance Trust, Baillie Gifford’s Scottish Mortgage Trust and the Murray Income Trust run by Aberdeen Asset Managers.

Top of the table are the City Investment Trust and Bankers Investment Trust, which can both boast 48 years of consecutive increases. Alliance Trust joined them on 48 on Friday, when it announced a dividend increase of 14.3 per cent.

But while a long record of increasing dividends is noteworthy it doesn’t necessarily mean those companies boast particularly high yields. Several of the trusts identified as “dividend heroes” have markedly modest yields, Trustnet data show, including Scottish Mortgage (1.1 per cent), the Scottish Investment Trust (1.89 per cent) and the F&C Global Smaller Companies trust (0.85 per cent).

Trusts in the sector are busy highlighting their dividend pedigrees ahead of next month’s reforms which are expected to result in far more people choosing to manage their own investments in retirement.

Amanda Forsyth, investment manager at Murray Asset Management, said: “Even with inflation seemingly under control it is a constant battle for the private investor seeking to maintain the purchasing power of their income.

“An unbroken track record of dividend increases is undoubtedly attractive and it is no surprise that the likes of Bankers Trust and City of London Investment Trust are a mainstay of many portfolios where there is a need to generate income.”

The compounding effect of dividends makes them a key driver of investment growth (and especially valuable when interest rates are low). Reinvested dividends accounted for more than two-thirds of returns on UK stocks over the past 100 years, the most recent Barclays Equity Gilt Study found.

And the outlook for income-generating trusts is positive, said Forsyth: “After the challenges of the credit crunch, company balance sheets are generally in good shape and, with some notable exceptions, dividend cuts are unnecessary. Indeed a number of companies (including Standard Life and Jupiter) have started to return capital deemed ‘surplus’ to shareholders.”

The ability of investment trusts to maintain dividends is due partly to what’s called “dividend smoothing”. This refers to trusts being allowed to set aside up to 15 per cent of their income each year so they can maintain payouts during the lean times.

“The investment trust structure has its advantages; they can accumulate reserves and therefore smooth dividend flows,” said Forsyth. “Gearing can also be employed to enhance both capital and income returns but not to the extent that the long term capital performance of the trust is jeopardised to cover today’s dividend payment.”

There is a potential downside to focusing on dividend records, however, as the fear of breaking a run of increases could result in wrong decisions being taken.

“No board should pressure a manager to the extent that short-term investment strategies are employed to boost revenues, eg ‘dividend stripping’ [buying a share immediately before it goes ex dividend] to meet the next payment, or sticking doggedly to a ‘yield trap’ share whose apparent value hinges on an unsustainable dividend promise,” said Forsyth.

Another concern is that trusts which invest primarily in the UK rely heavily on a small group of blue-chip stocks for their dividends. Just five stocks, including HSBC, BP and Vodafone, account for more than a third of dividends, according to Capita.

But investment trusts are increasingly sourcing their dividends from outside the UK. Several of those focusing on Asia have posted above-average dividend growth, the AIC report found. They include the Henderson Far East Income trust, with a yield of 5.4 per cent, and the Aberdeen Asian Income (4 per cent).

Annabel Brodie-Smith, communications director at the AIC, said: “The significant increase in dividends of these investment companies is reflective of fast growth in certain areas such as Asia and some of the special features that investment companies have when it comes to income.”

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