Ride the dividend recovery with City of London Investment Trust

In a year marked by savage dividend cuts, UK equity income investors might finally have some cause for optimism. Link Asset Services’ latest UK Dividend Monitor report says that “some signs of light” are finally appearing for income hunters. This includes companies resuming their dividends, fewer dividend cuts being made, and greater clarity over the state of companies’ operations. But despite Link forecasting a fairly attractive average yield of between 3.3 and 3.6 per cent for the UK market in the next 12 months, challenges remain. So while UK equities could still form part of an income portfolio, it may be best to get exposure to them via a fund with a resilient and selective process.

One fund that has stood out as a UK equity income play in difficult times is City of London Investment Trust (CTY). It trust looks to grow income and capital over the long term by mainly investing in UK equities and had a dividend yield of nearly 6 per cent as of 23 October.

The trust's board has maintained a focus on increasing its dividend and has now done this for 54 years in a row. Like many other closed-ended equity income funds, City of London Investment Trust can draw on revenue reserves to cover income shortfalls in difficult times. The trust has revenue reserves worth £45.62m, which could cover over half a year's worth of the dividends it is paying in its current financial year, according to the Association of Investment Companies (AIC).

The trust cannot entirely escape the concentrated UK market, where just a handful of stocks account for much of the income, and has been hit hard at a time when many investors are fleeing UK assets. On a total return basis, the trust’s shares were down by 18.5 per cent in the year to 22 October, lagging the FTSE All-Share index. Investment trust shares can fall further than the markets they invest in during times of volatility because of their ability to gear – ie, take on debt.

However, Job Curtis, manager of City of London Investment Trust, can take defensive measures that should protect the portfolio in the longer term. As he recently explained, the trust is underweight troubled industries that make up a big part of the UK market, such as oil and gas. Mr Curtis has also exited positions in leisure and hospitality names such as Cineworld (CINE) and Whitbread (WTB) this year.

The trust is well diversified, with 89 holdings at the end of September and allocations to overseas equities such as Microsoft (US:MSFT). The trust can have up to 20 per cent of its assets in overseas listed equities, and at the end of September had 14 per cent in these.

City of London Investment Trust’s defensive approach may appeal to investors looking to boost their income in a struggling market, and can offer cautious exposure to what could be an eventual recovery in dividends. A number of the trust’s holdings have already resumed dividend payouts this year, and it also has limited allocations to challenged sectors that could eventually recover.

UK equity investment trust share prices could remain volatile for some time as the UK grapples with the Covid-19 pandemic and ongoing Brexit uncertainty. City of London Investment Trust is also not the cheapest of UK equity trusts, in so far as its shares are trading at a small premium to the trust’s net asset value (NAV). The average UK equity income trust’s shares traded on a 7.5 per cent discount as of 19 October, according to broker Winterflood.

The premium, however, reflects the fact that City of London Investment Trust is defensively positioned and has a solid commitment to paying what is an attractive dividend. And the trust's rating is not high relative to its history – it typically trades a a slight premium – and on the odd occasion it moves to a slight discount this does not last long.

So with good yields still proving hard to find among UK equities, City of London Investment Trust could form part of an income portfolio for patient investors. Buy. DB