Last month Aberdeen Japan Investment Trust (AJIT) announced plans to change its strategy to pay a higher level of dividends, which it will do in part by drawing on its capital, rather than just relying on the income from the companies it invests in. For its financial year ending 31 March 2020, Aberdeen Japan hopes to pay shareholders at least 15p per share, up from 5.4p in respect of its last financial year ended 31 March 2019. It would fund this via dividends from its underlying holdings, 3p from its revenue reserve and an amount from its capital reserves which it expects to be at least 5.2p or 0.85 per cent of its net assets.
The trust’s board wants to pay an enhanced dividend to limit share price volatility, rather than relying on share buybacks to do this.
“A regular, sustainable dividend will help the trust to broaden the shareholder base and maintain the discount at reasonable levels," stated the trust’s board. “The revised dividend policy should improve the [trust’s] appeal amongst investors. Investors increasingly are taking a total return view of their investments and [we] recognise the importance of income to our shareholders. Investors are seeking reliable income alongside capital growth, influenced by the current low interest rate environment and the recent changes to pension rules. Investors will welcome a higher level of distributions, without changing the investment policy of [the trust].”
Aberdeen Japan’s board also says that Japanese companies are increasingly aware of the benefits of returning income to shareholders by way of dividends and share buybacks, as well as an increased focus on governance. This has enabled the trust to build up a reasonable level of revenue reserves.
Until now, Aberdeen Japan has paid a dividend marginally greater than the 85 per cent of its income required to maintain investment trust status. Shareholders will vote on the proposal for enhanced dividends at Aberdeen Japan Investment Trust’s annual general meeting in July.
Most investment trusts pay dividends from the revenue they get from their underlying investments. However, a small but growing number over the past few years have amended their articles, thereby enabling them to pay dividends from capital, after the rules on this applying to UK domiciled investment trusts were changed in 2012. Trusts that were listed in London but domiciled offshore were able to do this before 2012 – for example, European Assets Trust (EAT) – although the trust has since changed its domicile to the UK.
Investment trusts that pay an attractive level of dividends often trade at tight discounts to net asset value (NAV) or premiums because they are in high demand. So a trust that has persistently traded at a discount could over time experience a tightening of its discount if it increases its payouts. Aberdeen Japan’s discount to NAV was 14.2 per cent at close of play on 29 May, the day before it announced its proposals for an enhanced dividend, and it has often traded on a double-digit discount of around 10 per cent or wider over the past three years. But even though the proposals have not yet been approved it had already tightened to around 11 per cent by close of play on 25 June.
Paying enhanced dividends rather than making more share buybacks would mean the trust does not have to shrink further: it only has a market capitalisation of £81m and assets of £105m.
Another benefit of paying dividends from capital is that a trust can pay shareholders a higher income without having to change what it invests in, and could continue to invest in areas that typically don’t pay dividends. The trust’s manager would not be forced to buy assets such as equity income shares, which often do not have a high growth profile, and in some cases are not on attractive valuations because of their popularity with income-hungry investors.
Karen Brade, chair of Aberdeen Japan, says: “The [trust’s] investment manager will be focused on maximising the total return to shareholders without being constrained by the objective of generating sufficient revenues to cover dividend payments. He has wide flexibility in executing the mandate and is free from any income considerations in stock selection.”
And David Liddell, chief executive of online investment service IpsoFacto Investor, says: “This is beneficial to investors who want income and exposure to Japan, because it is not easy to get income from this area. Paying dividends from capital enables a wider variety of investors to participate in asset classes that may not have high yields.”
Downsides to drawing fro capital
Discounts have narrowed on other trusts that have introduced an enhanced dividend policy, such as Standard Life Private Equity (SLPE) and BMO Private Equity (BPET). But Daniel Lockyer, senior fund manager at Hawksmoor Fund Managers, points out that "we have been in an equity bull market and private equity has performed well".
And in some cases, an enhanced dividend policy has not succeeded in narrowing trusts' discounts to net asset value (NAV), or has not worked all of the time, especially if the trust has other problems.
For example, BlackRock World Mining Trust (BRWM) has been paying out a higher level of dividends since 2012 and embarked on a tightening trend for a few years after this. But since then its discount to NAV has widened again and is 13.4 per cent, albeit tighter than around 17 per cent as it was on at the start of 2012. Part of the reason for the widening was because BlackRock World Mining Trust had problems with some of its unlisted investments during 2014 and 2015. And at present, its NAV returns have under performed EMIX Global Mining Index over one, three and five years, according to Winterflood. Although it continues to pay an attractive level of dividends and is on a yield of 5.1 per cent, this alone is not enough to keep it on a tighter discount.
Securities Trust of Scotland (STS) changed its dividend policy in 2015 and has been paying a higher level since 2016. But this generally hasn’t resulted in much change in where its discount generally trades, although the trust had come into a discount of 1.5 per cent at close of play on 25 June. Its 12-month average discount is 5.2 per cent. The trust has underperformed FTSE World index over three and five years, although this is not its official benchmark.
Martin Currie Asia Unconstrained Trust (MCP), meanwhile, has recently proposed winding up for reasons including its shares trading at a steep discount to NAV. This is despite various attempts by its board over the past few years to try to tighten it, including changing its investment policy in April 2017 so it could pay a higher dividend by drawing on capital. At close of play on 3 June, before the trust announced its intention to wind up, it was trading on a discount to NAV of 12.7 per cent. Perhaps ironically, as a result of its plans to wind up its discount had narrowed to 0.7 per cent by close of play on 25 June. The trust's NAV returns have underperformed MSCI AC Asia Pacific ex Japan index over one, three and five years.
A higher level of income from a fund could also have personal tax implications for its investors, although this is not a problem if you hold it within a tax-efficient wrapper such as an individual savings account (Isa) or self-7invested personal pension (Sipp). Outside these wrappers you can receive dividends from your investments worth up to £2,000 a year tax-free, after which you incur dividend tax, the level of which depends on which tax band you are in. So, if you hold a trust that increases its dividend payouts outside a tax-efficient wrapper, you need to review what effect it will have on your personal taxation.
Another disadvantage of paying dividends from capital is if markets go down and a trust has to pay out a percentage of its NAV, it will be harder for it to recover when markets go up because it has a smaller capital base.
But Ms Brade argues: “Since the change of mandate to ‘Japan only’ in October 2013, the [trust’s] shareholders have seen an increase of 69 per cent in NAV, equivalent to 9.4 per cent a year, even after paying distributions. Over this period the trust has paid dividends totalling 27.9p, which have ranged between 0.7 per cent and 1.2 per cent of starting NAV. Thus there has been substantial headroom for the trust to pay significantly higher dividends than those actually paid, without endangering a continuing growth in NAV. The board has stated that it will look to pay out the full amount of earnings for a financial year together with an incremental amount from the revenue reserves which have built up over time. The amount payable from capital, using last year as an example, would have been less than 1 per cent of NAV. While in falling markets such a policy will increase a reduction in NAV, the board believes that growth prospects for many companies in Japan are excellent. Accordingly, they propose to adopt a distribution policy consistent with rising NAV over the medium term.”
Paying a higher level of dividends could help Aberdeen Japan narrow its discount further, so this is definitely one to watch. But Aberdeen Japan has underperformed the Topix index over one, three and five years, and for the most part its sector peers.
Paying dividends from capital alone will not necessarily change the fortunes of an investment trust – good total returns are also important. And as an investor, there is no point in receiving high dividends if your capital is being eroded.
