Capital and income: Investment companies paying dividends out of capital

Since a change to the tax rules in 2012, UK investment trusts have had the ability to pay dividends from capital profits. The vast majority of investment companies pay dividends out of the income they receive from their own portfolio but a number of investment trusts are paying dividends from capital profits.

To help investors understand whether an investment company’s dividend is paid from income or capital profits, the Association of Investment Companies (AIC) has introduced enhanced dividend information for each member company on the AIC website. This shows the investment company’s dividend history and highlights whether each dividend was paid from income or capital.

In addition to this information, the AIC website shows the revenue reserve of an investment company, the undistributed income that the company keeps as reserves shown in millions. This is the ‘rainy day fund’ that investment companies can use to top up dividends in leaner times, which is made up of income that has been earned in previous years but not paid out.  The AIC is also publishing the dividend cover, which shows the number of years the current revenue reserves can last based on paying the last full financial year of dividends.

Ian Sayers, Chief Executive of the Association of Investment Companies, said: “Paying dividends from capital profits is an additional income advantage of investment companies. 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. Clearly investment company boards have an important role to play overseeing any change in dividend policy and ensuring it is in shareholders’ best interests.

“We are now publishing enhanced dividend information on our website to help investors in their decision making. It’s clear that the demand for income remains strong and we want to provide as much data as possible to help investors research investment companies that will meet their income needs.”

To shed light on the decisions that investment companies have taken to pay income from capital, the AIC has collated comments from Sam Cosh, Manager of European Assets Trust; Nigel Wightman, Chairman of JPMorgan Global Growth & Income; Harry Wells, Chairman of Martin Currie Asia Unconstrained Trust and Rachel Beagles, Chairman of Securities Trust of Scotland.

Sam Cosh, Manager of European Assets Trust, said: “European Assets is unique amongst investment companies in that it is a Dutch domiciled company but has a London listing. Until quite recently the Dutch tax rules differed from the UK rules in that all “reserves” are available for distribution to shareholders in the form of a dividend. Back in 2001, the board of European Assets adopted a “high distribution” policy and provided shareholders with an income calculated as a percentage of the year end net asset value. For the past seven years or so this has been at a rate of 6% per annum.

“Interest rates have been at historic lows for many years and have been falling for the best part of three decades, and bond yields have tumbled as a result. Investors have been seeking income from other assets for some time now. European Assets invests in smaller companies across Europe and these companies do not tend to be high dividend payers because they are growth businesses so tend not to find their way in to income seekers’ portfolios. The structure of European Assets allows the board to pay dividends from capital and by holding the trust, an income investor can diversify their own portfolio into an area that is typically not income producing.”

Rachel Beagles, Chairman of Securities Trust of Scotland, said: “In July 2015 the board agreed that it was comfortable using its authority to enhance the annual dividend by distributing some capital profit by way of dividend, as necessary.

“In an unusual step, the board also announced the minimum total annual dividend for the financial year ahead to March 2016 - which was an 18.4% increase on the previous year, and a progressive policy thereafter.

“This offered our shareholders both an attractive yield, underwritten by retained revenue and capital reserves, and a level of income certainty that was prized during a time of market volatility and enduring low yields.

“In adopting this approach, the portfolio manager retains full flexibility and control over stock picking without sacrificing high quality companies poised to deliver a high total return over the long term in favour of yield.

“Earlier this year the board declared a fourth dividend of 1.6p, bringing the total dividend for the financial year ending 31 March 2017 to 5.95p a rise of 2.6% on the prior year. Just 0.21p per share was paid from retained revenue reserves. 

“If necessary, going forward, the board will fund a portion of the dividend using capital reserves; the fact that the option is available within the investment trust structure offers a tangible benefit to our shareholders.”

Nigel Wightman, Chairman of JPMorgan Global Growth & Income, said: “In July 2016, the board decided to move to a new distribution policy of returning 4% of NAV to shareholders, each year, through quarterly dividends. As many investors continue to seek out investment opportunities which offer a reliable level of income alongside capital growth, we feel that the company remains as relevant as ever and has a role to play in easing the burden of an ultra-low interest rate world.

“This policy seems to have been well received with renewed interest in the company’s shares. The board has just announced that, in relation to the year commencing 1 July 2017, the company intends to pay dividends totaling 12.16p per share, which represents a yield of 4.01%. It is expected that such dividends will be paid by way of four equal distributions.  This represents an increase of 24.1% over the total dividends of 9.8p paid in the year to 30th June 2017, reflecting the strong NAV growth over the year.

“While the investment outlook is unquestionably mixed, the board believes the manager’s robust investment process and extensive internal research resources which remains unchanged following the revised distribution policy will continue to be able to identity attractively priced high quality companies in which to invest for our shareholders.”

Harry Wells, Chairman of Martin Currie Asia Unconstrained Trust, said: “In July, shareholders of the Martin Currie Asia Unconstrained Trust overwhelmingly voted in favour of a proposal to increase the dividend payment by introducing a distribution from capital. This increased the total annual dividend by 110% on the previous financial year. It is the board’s intention to repeat the capital distribution in future years to be paid on an annual basis along with the final dividend and set by reference to 2% of the prior year-end ex-income Net Asset Value (NAV).

“The board believes that the new dividend policy benefits existing shareholders, whilst making the shares attractive to new buyers and appealing to retail investors, who will be able to participate in the potential for capital growth.”

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Notes

1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs.  The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 349 members and the industry has total assets of approximately £167 billion.
2. Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.