AIC views

9 February 2009

Income seeking in a low interest rate environment

In this article, Annabel Brodie-Smith, AIC Communications Director, explores dividend track records in the investment company sector.

The Bank of England’s latest economic lifeline, the 0.5% reduction of the base rate to 1%, marks yet another precedent – the lowest interest rates for 300 years.  Whilst we now dare say the ‘R’ word (recession is nothing new to the UK after all), it’s fair to say that we are now in uncharted waters. 

Of course the latest reduction will hopefully be good news for business looking for some economic respite.  And it’s great news if you are one of the lucky  few with a tracker mortgage that follows the base rate and is not subject to a “collar”.  But income seekers have their work cut out and savers are suffering too. 

So where to look for income?  Whilst the outlook for UK companies remains harsh and we will see some more businesses cutting their dividends in these difficult times, there are options out there for income seekers, and the investment company sector is one area that is worth consideration.

Investment companies uniquely among retail investment funds are in the enviable position of being able to ‘smooth’ dividends.  Namely, they can retain part of the dividends they receive each year and transfer these to their revenue reserves. These revenue reserves can be built up in good years and used to boost dividends to shareholders in more difficult years.  This is one of the reasons why investment companies have an unparalleled track record when it comes to increasing their dividends.  AIC research recently found that of all the 159 conventional investment companies with 10 year or longer track records, a fifth (20%) have increased their dividends for each of the last 10 years.  Of all the 78 conventional investment companies with 20 year track records, nearly a quarter (24%) have increased their dividends in every single year of the last two decades.

Interestingly, Peter Ewins, manager of F&C Global Smaller Companies PLC, believes that the best way of seeking out long-term income growth is to look at companies with a progressive approach to dividends.  Speaking to the AIC, Peter Ewins said: “The severe economic slowdown is putting pressure on dividends across the globe. Over the years F&C Global Smaller Companies has targeted those businesses with strong long-term growth prospects. Although initially many of these will have relatively low yields, as these businesses mature and generate positive free cash flows they are better positioned to grow their dividends. We feel this targeting of businesses offering progressive growth in dividends is preferable to buying stocks that may immediately offer a high yield but with limited growth prospects.

“While pressure is on dividends, F&C Global Smaller Companies has a large revenue reserve on which it can draw. This helps the trust protect its ability to maintain its record of increasing dividends through tough times.” 

Indeed F&C Global Smaller Companies has increased its dividend for each of the last 38 years, and there are a number of investment trusts with even longer records of annual dividend increases.  There are options out there for those looking for income, but as the goalposts have shifted, some may find that they now have to take on some stockmarket risk in the process.  The old adage ‘there’s no such thing as a free lunch’ has never been more true.

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