The strong post-Covid performance of Merchants (MRCH ) stalled last year as the UK equity income trust suffered a double blow from the intervention of the Financial Conduct Authority against two of its holdings.

Fund managers Simon Gergel, Richard Knight and Andrew Koch took the ‘difficult decision’ to sell St James’s Place (STJ) after the wealth manager was forced by the FCA to overhaul its charges.

The company, which Merchants had held since 2018, subsequently set aside £426m to refund clients who had paid for but not received advice, requiring a halving in the dividend.

The managers ditched the stock before then but, with the shares going on to halve in the 12 months to 31 January, Merchants reported St James’ woes had knocked 1.1% of its annual return.

Writing in the annual report they said the new business model would be good for consumers and ultimately might shore up St James’s Place’s market position, but in the short to medium term created big risks and uncertainties.

‘There is a lengthy delay until the changes take effect, and in the meantime there are risks of operational difficulties, customer and partner confusion, and further regulatory intervention,’ they said.

‘Investors must also become comfortable with a very material step down in cash generation when the new model begins, before growing relatively strongly in the following years. This unusual profile of cash generation creates additional uncertainty,’ the managers added.

Close Brothers (CBG) also weighed on the portfolio, knocking 0.7% off Merchants’ annual return after the FCA launched a review of historic commissions paid by the company for selling car finance that could have ‘a material impact on the company’.

‘Other issues, such as the impact of lower asset prices in its wealth management business, are more normal, cyclical concerns. But the combination of events this year had a major impact on the shares,’ said the management trio.

In what the chair Coilin Clark called a ‘disappointing’ setback after good returns in the previous two years, the £789m trust dropped 2.5%, trailing a modest 1.9% increase in the FTSE All-Share. That was despite some positive performances from high street fashion chain Next, builders Redrow and Bellway and distribution company DCC.

Merchants’ record remains strong with the latest data at 8 April showing net asset value growth of 25.3% and 46.6% over three and five years, ahead of the All-Share’s 21.8% and 27.2%.

A recent weakening in the shares has seen them slip to a 3.6% discount to NAV, reducing shareholder returns to 19.1% and 39.4% over three and five years.

Despite the stock setbacks, income from the portfolio was strong with revenue earnings per share rising 6.3% to a record 30.5p.

This enabled the board to declare a final dividend of 7.1p, giving a total payout for the year of 28.4p, up 2.9% on the 27.6p paid in the previous year. The 5%-yielding ‘dividend hero’ of the Association of Investment Companies has now paid a consistently rising dividend for 42 years.

The managers added seven stocks to the portfolio and sold out of nine in the year. It bought building materials group Marshalls (MSHL), car dealer Inchcape (INCH), reinsurer Lancashire (LRE), and Lloyds (LLOY), with the latter two being switches from Swiss Re and Natwest (NWG), respectively.

Merchants found some ‘particularly interesting situations’ outside of the UK, and made an investment in Spanish-listed airports operator Aena, which is majority owned by the Spanish state. It has 46 airports in Spain but concessions in central America, Brazil, and Luton in the UK.

‘Under a favourable regulatory structure, it earns a fair regulated return on its capital invested to provide airport capacity to aircraft landing in Spain, but it is able to earn a higher, unregulated return on commercial activities, such as renting space for duty free shopping or restaurants,’ they said.

‘Overall, the company makes attractive financial returns and has reasonable growth potential, whilst modest capital investment requirements mean the business is cash generative and able to pay a healthy dividend to shareholders.’