A hero’s welcome

Football’s Premier League may grab almost all the headlines on the sports pages, but the Championship, the next division down, is very often a more competitive and exciting league. You might say exactly the same of the investment company universe.

The Association of Investment Companies’ “Dividend Heroes” – 20 funds that have raised their dividends in each and every year for 20 years or more – rightly get lots of publicity. But there’s a second group of star performers that many people don’t know about. A further 22 investment companies have raised their dividends every year for at least 10 years, but not yet made it to the 20-year mark.

These funds, dubbed the “next generation” by the AIC, are a remarkably mixed bunch, offering income-seeking investors a much broader choice than the Premier League of Dividend Heroes. There are no fewer than five representatives from the Asia Pacific sector, for example, which is surprising given the relative lack of a dividend-paying culture in many Asian countries.

In addition, the next generation includes three Europe funds, a pair of Infrastructure specialists, and one fund each from the Flexible Investment and Global Equity Income sectors.

The remainder are UK-focused investment companies, but even here there’s a good range of choice on offer, spread between equity income funds, smaller companies vehicles and a generalist.

This diversity is important. The dividend heroes stand out for their consistent record of paying a rising income, which is obviously important to anyone looking for dependable yield. But income seekers, just like any other investors, also need to be conscious of asset allocation basics; they need a spread of funds in their portfolios – large cap and small cap, UK and international, and so on – to provide diversification benefits.

Securing that diversification while simultaneously focusing on income isn’t always straightforward. Not least, some asset classes and sectors that you might turn to for asset allocation reasons don’t have a track record of paying consistent levels of income.

It’s here that investment companies come into their own. Since a closed-ended fund is allowed to retain up to 15 per cent of earned income each year – a facility that is unique to investment companies – it is able to smooth out income distributions over time. In good years, these funds hold back some income in order to subsidise dividends in more challenging periods.

This is why investment companies determined to raise their dividend each year are able to do so, assuming they plan carefully. As a result, investors can access asset classes that tend to have lumpy income distribution patterns while still being able to count on yield. For portfolio planning purposes, that is invaluable.

In time, many of the next generation will graduate to the AIC’s “A list” of dividend heroes. No fewer than nine funds on the list have already racked up 15 years of income increases or more. But advisers and investors should continue to consult both rankings as they consider their options for reliable income. As many football fans have discovered, the Championship might just prove to be a better home for your money than the Premier League.