European Assets' dividend falls 22% due to NAV decline

The trust's NAV total return per share fell 15.4 per cent in sterling and 16.3 per cent in eEuros over the year to 31 December 2018, in contrast to a fall of 12.7 per cent in sterling or 13.6 per cent in euros for its benchmark, EMIX Smaller European Companies (ex UK) Index. As a result the trust's board said 2019’s dividend will be €0.0684 (£0.062) per share, down from €0.088 per share in 2018.

"[In 2018] we reduced our cyclical sensitivity and exposure to high financial leverage," said the trust's board. "While a sensible strategy, these changes were not enough to withstand the severity of some of the moves that we have seen... This underperformance can almost be attributed entirely to a very poor April, when we significantly lagged a strong market led by sectors where we had little exposure. More recently, there has been weaker performance in our remaining cyclical holdings. At this stage we would argue that these stocks now look excessively cheap, discounting a somewhat more severe economic scenario than we would envisage. In aggregate our companies are good businesses, with limited debt, and are attractively priced. This should stand us in good stead for the year to come."

And Monica Tepes, investment companies research director at broker FinnCap, argues that an enhanced dividend policy has helped keep European Asset's discount tighter than those of other European smaller companies investment trusts – despite the fact it has made the worst NAV total returns over three and five years.

“This has helped enormously as its [yield] is significantly above the market yield," she said. "The fall is only temporarily a problem, and to a limited extent given the high level the dividend is set at. For new investors, a 6 per cent-plus yield is still very attractive and existing investors are still lacking alternatives on a higher yield."

European Assets has linked its dividend payments to its NAV since 2001 and Numis says over the past three years 10 other trusts have implemented policies linking dividends to NAV. However, 2019 is likely to be the first period since these policies were introduced where investors could see income fall due to the volatile equity markets. Ewan Lovett-Turner, director of investment companies research at broker Numis, said investors relying on trusts that use capital to pay dividends could face more income volatility than those that fund dividends from the income they receive from their holdings and their revenue reserves. 

“The jury is still out on the success of paying an enhanced yield from capital,” said Mr Lovett-Turner. “As well as the potential for greater income volatility, the impact of paying an enhanced yield on capital returns is disguised in rising markets, but will accentuate NAV losses when markets fall. Paying an enhanced yield is unlikely to turn around the fortunes of a fund with a poor performance record or where the asset class is out of favour.”

Sarah Godfrey, director of investment companies at Edison, also pointed out: "It’s important when dealing with a set percentage distribution policy to understand that this will result in fluctuating annual dividends. In unfavourable market conditions, being obliged to pay out a set percentage of your NAV when you don’t have the capital profits to cover it will result in capital erosion and could become a downward spiral. But markets do tend to go up in the long run, however, so both dividends and capital can recover."

Part of the reason why these trusts introduced these income policies was to attract new investors and narrow their share price discounts to NAV. “Initial evidence suggests that a higher yield does create marginal buyers," said Mr Lovett-Turner. "Given the strong demand for yield in a low interest rate environment, it comes as little surprise that many have decided to pay an enhanced yield in order to attract new investors.”

Trusts with NAV-linked dividend policies

Source: Numis