More trusts paying dividends from capital

The AIC has published detailed information on whether member trusts pay income out of income or capital for the first time, revealing that 21 investment trusts are either paying, or plan to pay, income from capital reserves – 6 per cent of its members.

Those include RIT Capital Partners (RCP), which AIC data shows has paid every dividend to shareholders since June 2012 from capital. As of 7 August the trust had a yield of 1.6 per cent. Invesco Perpetual UK Smaller Companies Trust (IPU) has paid out its dividends from a mix of capital and income since 2016. As of 7 August it was yielding 3.5 per cent. And European Assets Trust (EAT), also makes regular payments out of capital as well as income, which it has been doing since before 2012 due to its offshore domicile in the Netherlands.

Capital reserves are profits generated from the sale of shares owned by a trust and are separate from the revenue reserves trusts can build by holding back up to 15 per cent of their dividend earnings each year. Since 2012, trusts have been allowed to pay out dividends to investors either by taking profits on their holdings or from the revenue they receive as income.

AIC chief executive Ian Sayers said the low yields on bonds and equities combined with strong capital growth could be leading more trusts to turn to capital reserves for income. "Paying dividends from capital profits is an additional income advantage of investment companies trusts," he said. "It helps meet shareholder demand for income in this low interest rate environment and potentially can lead to investment companies being rerated to trade on lower discounts, another benefit for shareholders."

Simon Elliott, head of research at Winterflood Securities, said: "The ability to use revenue reserves to provide greater dividend certainty is well established and appreciated by the market." 

"It has allowed a number of investment trusts to develop impressive records of year-on-year dividend growth. The ability to convert capital into income takes this a stage further and allows funds investing in low or non-yielding assets the opportunity to pay regular dividends."

But paying dividends out of capital is contentious, with many investors uncomfortable with the idea of sacrificing portfolio growth for the sake of income and potentially limiting future capital returns. In the five years since trusts have been allowed to distribute capital profits as dividends, the majority have chosen to stick to paying out of income. 

Charles Cade, head of investment companies research at Numis Securities, said: "At the moment markets are fairly strong and investors are kind of having their cake and eating it [by benefiting from capital growth and enhanced dividend income].” 

“But in a bear market if a fund’s net asset value (NAV) falls and you’re paying out dividends from the capital, the fund’s NAV will be hit more and investors will lose more capital."

As part of the new research, the AIC has also published the trusts with the most sustainable dividend payouts based on current revenue reserves, based on the last full financial year of dividends. Of the trusts paying income out of capital, Baring Emerging Europe (BEE) and Invesco Perpetual UK Smaller Companies (IPU) are the best covered. Baring Emerging Europe has 2.4 years' of dividends covered by its reserves. Invesco Perpetual UK Smaller Companies has 2.43 years' worth of dividends held in reserves.

Source: The AIC (list does not include Venture capital trusts or trusts that have paid dividends from capital profits on an irregular basis or those whose Articles of Association allow them to do so but have not put forward any clear policy to do so in future)