When an investment trust board talks about “resetting” its dividend, we might normally view this as code for a cut. But not so with Alliance Trust (ATST), whose board recently announced that it will increase this year’s third interim dividend to 5.825p, with the same level expected for the fourth interim dividend. 2021's payouts should represent a 32.5 per cent increase on 2020, with the dividend continuing to rise each year beyond that.
There’s some interesting thinking behind this. According to the board, shareholder feedback has indicated support for a higher dividend, provided this is both sustainable and affordable. The board, for its part, feels that an expected recovery in portfolio income and its hefty distributable reserves mean the increase is affordable. The board also believes that a higher dividend should “reinforce Alliance Trust’s position as an attractive core global equity investment”. If a higher payout draws more investors in that could bolster the share price.
It should be noted that the new quarterly dividend still only equates to a relatively modest yield of some 2.2 per cent a year, but in fairness plenty of total return vehicles now offer small dividends to please investors. But if income has become a tool with which to coax in new shareholders, how exactly is it funded?
This is the excellent question Numis analysts have posed in response to the Alliance Trust news. The trust's dividend policy and investment approach remain unchanged, with the payouts funded from income and, if need be, distributable reserves. But it should be noted that such reserves are looking much greater after a £645m merger reserve was made distributable this summer. Other trusts have taken similar measures, such as transferring special reserves, to top up the amount they have available.
More importantly, Numis notes that the line between capital and income has become “increasingly blurred”, with most funds now able to distribute unrealised capital profits. As the analysts put it, investors now need to be much more interested in where their income is actually being generated. They should ask if they are happy with dividends being funded (partially or wholly) from capital. As we’ve previously discussed, paying dividends from capital can eat away at a portfolio if done in a bear market.
As Numis notes, some names such as Scottish Mortgage Investment Trust (SMT) and RIT Capital Partners (RCP) have tended to partially use reserves to fund dividend increases. Many others have opted to pay out a fixed proportion of net asset value, regardless of the level of portfolio income. Several JPMorgan growth and income equity trusts do this, as do names such as International Biotechnology Trust (IBT), BB Healthcare Trust (BBH), European Assets Trust (EAT), Invesco Perpetual UK Smaller Companies Investment Trust (IPU) and a handful of private equity trusts.
The Numis analysts add that they have often seen this approach boost demand for such trusts, despite many investors in principle being opposed to turning capital into income. But each investor must weigh up the pros and cons on their own. Is it good for a total return vehicle to use its capital for income? As with your own investments it may make sense for a trust to buy the best investments, rather than just high-yielders, and cash in the capital gains for income. But it's a strategy that can go badly in difficult markets.
