All-time high

The headline news is impressive enough: investment company dividends rose more than 15% over the year to the end of March, according to Link Group, hitting an all-time high of £5.5bn. But the more interesting story here is what has contributed to those numbers – this is a tale of how the investment companies sector delivered what it promised while also innovating for success.

Let’s start with the delivery part. The majority of investment companies are stock market-focused; they buy portfolios of equities which managers hope will deliver both income and capital gains. But actually, this is not where the sector’s income growth is coming from – investment companies invested in listed equities generated £1.85bn of dividends over the year to 31 March, almost completely flat on the previous 12-month period.

Why so little growth? Well, investment companies are special; unlike other collective investment vehicles, they are entitled to hold back some of the income they earn on their investments each year in order to build up reserves. This cash can then be used to subsidise dividends to investors in years when the investments aren’t generating enough income to fund pay-outs.

This is exactly what has happened. During the Covid-19 crisis, as listed companies slashed their distributions, investment companies were able to dip into their reserves to fund dividends. As a result, remarkably few funds cut their payments to investors during the pandemic.

Now that listed companies have returned to making distributions, investment companies are replenishing those reserves – building up more cash ready for the next crisis. This is why their dividend pay-outs were flat over the year to March – and why Link forecasts only 4% growth in the current year, even though listed companies are increasing their own dividends at a much faster rate.

In this sense, investment companies are doing exactly what they promised their investors. They are smoothing out the ups and downs of the dividend profile of the stock market, providing investors with a steady and reliable stream of income over time – even in the most trying of circumstances.

As for the rest of last year’s pay-outs, that’s the innovation part of this story. Funds invested in alternative assets – particularly infrastructure, property and venture capital – paid out £3.65bn of dividends over the year to 31 March, Link says. That was a 25% increase on the previous 12 months – and ten times more than such funds paid out in 2010.

Indeed, the growth of funds offering exposure to alternative assets has had a remarkable effect on the investment company industry. In 2010, these funds accounted for less than a third of the income generated by investment companies; over the past year, they produced two-thirds of it.

Investment companies have embraced alternative assets because managers recognise that they are uniquely well-placed to offer investors access to what are typically illiquid investments. The fact that investment companies are stock market-listed vehicles, offering daily dealing in their stocks, provides investors with comfort when putting money into asset classes such as venture capital and property, where they usually have to commit to tying up their cash for an extended period with little recourse to withdrawals.

The fact that investors now have easy access to infrastructure, private equity, venture capital, hedge funds and property – not to mention more esoteric areas such as music royalties and aircraft leasing – is an exciting example of financial services innovation. And, as we see from Link’s data, this innovation has also provided access to a whole new range of income sources.