Dividend of the Week

A few weeks ago, we promised that we would look at the investment trust sector to provide our readership with some good income generating trusts. This is a vast sector and readers are likely to come up with some really solid high yielders that this screen misses. To keep a lid on the results, we have restricted our universe to FTSE 350 companies. That said, it is DividendMax policy to add in any stocks that our members want us to cover and we will always react positively to requests for additional coverage.

Sometimes it is easier to sit back and watch others manage your money, while you focus on a few favoured stocks that you get to know very well. This approach can become expensive because, whichever way you look at it, you are paying a fund manager to manage your assets and in many cases they underperform the market. But this is not always the case, and sometimes you can gain exposure to sectors or situations that you do not understand by trusting the experts with your money. For that reason, it may be worth paying the price. Until recently I refused to cover the investment trust sector in our DividendMax analysis on the grounds that I believe you are better off managing your own money. But after some pressure from our clients, we initiated coverage of those in the FTSE 350.

The size of the sector makes me wonder just how much money has been lost by investors over the years as they give up a percentage of their gains in management fees, and these do not go away even if the fund manager actually loses you money. Unfortunately, I found in doing my research of investment trusts that they are a law unto themselves in the information that they provide online. Compared with their 'real economy' constituents of the FTSE 350, they have a lot to learn.

My initial search in DividendMax reveals that we cover 31 investment trusts in the FTSE 350, which immediately gives you an idea of the scale of the sector; almost a tenth of the FTSE 350. As we are interested in dividends, we set a yield criterion of 3 per cent over an 18-month timescale (most investment trusts pay dividends quarterly these days, so it is better to look over time rather than the number of dividends), which immediately reduced the list to 10. To further rationalise this list we then screened for trusts with a track record of consecutive annual dividend increases over five years or more as it should be a good indicator of the track record of the investment manager. This reduced the list to five:

Merchants Trust (MRCH), Perpetual Income & Growth Investment Trust (PLI), Murray International Trust (MYI), Temple Bar Investment Trust (TMP) and Edinburgh Investment Trust (EDIN).

In addition, we are going to add for consideration the high-yielding F&C Commercial Property Trust (FCPT), which pays a monthly dividend throughout the year and so could be of interest to investors seeking a monthly income. To further whittle the list down the next elimination criterion is the rate of historic dividend growth between 2006 and 2012. The three trusts with the lowest rate of growth will be eliminated.

F&C Commercial Property Trust stands out as the highest yielder of the group, but it is more akin to an annuity than a growth stock as it pays the same 0.5p dividend every month. For this reason, it is not a viable dividend of the week but we felt it was worthy of a mention as it does pay monthly. Its share price has ranged from 100p to 116p (where it is now) in the past 12 months and at the moment it looks fully priced.

Merchants Trust has 30 years of consecutive dividend growth from 4.2p in 1982 to 23p in 2012 and has performed well in three of the past four years, but had a bad year when the markets fell in 2008-09. It is eliminated at this point on the performance grounds outlined earlier. For the same reason, so is Edinburgh Investment Trust. Also, in the case of Edinburgh it is worth noting that the trust appears to have struggled to meet its investment policy in times of poor market performance. It publishes the following policy on its website:

The Company invests primarily in UK securities with the long-term objective of achieving:

1. An increase of the net asset value per share by more than the growth in the FTSE All-Share Index; and

2. Growth in dividends per share by more than the rate of UK inflation.

I guess it may depend upon which measure of inflation that you use, but it does not look to me that objective two has been met consistently: against the consumer prices index (CPI) measure of inflation the objective was met in 2007, 2011 and 2012 but not in 2008, 2009 or 2010.

Let's have a look at the dividend history for the remaining candidates:

Perpetual Income & Growth Trust

Murray International Trust

Temple Bar Investment Trust

Reading the investment objectives of the Edinburgh Investment Trust gave me the idea of benchmarking all of our remaining candidates against that criterion. I took the trouble of obtaining the UK inflation data from the Office for National Statistics from 2006 to 2012. It came in a spreadsheet containing 64 separate tables going into unbelievable detail. Not recommended reading. See below for a comparison of our remaining companies against the inflation benchmark. Remember, though, that any increase below the rate of inflation is, in real terms, a dividend cut.

From an income perspective, three clear winners emerge, so let us now investigate how they have looked after your capital over the years. Rather than use the websites of the individual trusts, we will rely on an independent third party, Trustnet, to provide the figures.

Perpetual Income & Growth Trust

Murray International Trust (ord. shares)

Temple Bar Investment Trust

So, from an income perspective the star performer is Murray International Trust and from a share price and NAV perspective it is Temple Bar, which to some extent you would expect as it distributes less income.

The recent strong performance of investment trusts in general and their growing popularity as an investment class has seen notable movements in share prices which, in many cases, has narrowed the discounts to their net assets. And it is not unusual at the moment to find trusts that are trading at a premium to their net assets, as are all three of our final candidates. The market loves Murray International Trust, which means it now sits on a hefty premium to NAV of 9.91 per cent. Temple Bar Investment Trust is trading on a premium to NAV of 1.99 per cent and Perpetual Income & Growth Trust is priced on a premium to NAV of 1.45 per cent.

My gut instinct is to ask why on earth would anybody buy anything that is worth more than its value, but these three stocks have emerged as our winners and it is interesting to discover that all three trade on a premium to NAV. Most people look at the discount when buying investment trusts. Clearly, in these three cases, you are paying for consistent performance of the fund managers themselves.

Once again, I find myself in a very tough position in trying to choose our dividend of the week. I canvassed the opinions of some hedge fund management contacts as to how much of a premium was acceptable when considering buying investment trusts and the conclusion was that a premium of almost 10 per cent is a little too rich even for a decent income-paying fund, but funds trading at a smaller premium are acceptable as the likely income and regularity of dividends could be worth paying for. Temple Bar has performed very well, but the combination of excellent performance and decent income makes Perpetual Income & Growth Trust our dividend of the week. It is worth noting that Perpetual Income & Growth goes ex-dividend on Wednesday 4 September for its first quarter dividend of 2.7p. Investors will have to be on the share register by the close of business on Tuesday 3 September to qualify for this dividend.