Princess Private Equity (PEY) appears not to be making friends. An announcement made on 2 November that the trust would suspend its second interim dividend for the 2022 financial year saw the share price plunge, with investors seemingly dismayed about the freeze and the lack of clarity on any reinstatement of the payout. Investec analysts described the suspension as a “deeply disappointing development”, asking why the trust hadn’t eased off on its programme of new investments beforehand in order to protect the dividend.
Princess seemed to run into some very specific problems, with the board noting the need to use €60mn (£52mn) to settle currency hedging contracts because of the US dollar strengthening against the euro. However, the incident reminds us of the risks that come with novel ways of generating income.
If the currency problems encountered by Princess seem quite specific to that trust, another challenge is that its payouts can rely on the fund generating cash by selling assets – something that proves difficult in tough market conditions like these. As Stifel analysts put it when the suspension was announced: “Dividend payments in the private equity sector are always a bit questionable given the portfolios don’t usually generate enough cash from revenue earnings to cover dividends, with these payments effectively being a repayment of capital.” Princess itself has pointed to challenging conditions “limiting the facilitation of asset sales”.
Investors may therefore wish to keep an eye on the extent to which other private equity trusts with a dividend, such as Apax Global Alpha (APAX), go about funding such a payout, and the extent to which they are still realising assets where relevant.
In recent years a few more equity trusts have taken to using capital, at least in part, to fund their dividends. We’ve noted that this has worked well so far for success stories like JPMorgan Global Growth & Income (JGGI) because doing this means it can avoid chasing yield - but difficulties can emerge if a fund’s holdings are down and it has to realise a loss to fund a dividend.
That’s one concern the specialists assessing this year’s Top 50 Funds list had when thinking about European Assets (EAT), a fund that has tumbled in the last year but tends to pay an annual dividend equivalent of 6 per cent of net asset value (NAV) on a given date. Beyond the risk of selling into a falling market, such an approach also leaves investors with a lower dividend if the NAV has dipped from one year to the next.
Finally it’s worth remembering that in the investment trust space funds can end up using a decent amount of gearing to generate a greater level of income. Stifel recently noted, for example, that the leverage used by Henderson High Income (HHI) came to 23 per cent at the end of September, compared with 20 per cent for CC Japan Income & Growth (CCJI), 17 per cent for JPMorgan China Growth & Income (JCGI) and 15 per cent for Abrdn Equity Income (AEI). Gearing can enhance returns when valuations rise, but it also hurts more on the way down.
As the dividend cuts of 2020 demonstrated, generating a 'natural' income from what a holding pays out also comes with its own issues. But it’s worth remembering that the more novel approaches do have drawbacks.
