Demystifying divis

If you have shares in investment companies, you probably have some grasp of the idea of dividend payments, especially if you’re relying on investment income to help pay the bills.

But while you may be familiar with dividends’ popularity and the big picture around them - the AIC’s dividend heroes, for instance - it’s a jargon-ridden world that can seem pretty impenetrable to the uninitiated. Below, we take a look at the workings of the humble investment company dividend.

Where do investment company dividends come from?

Many investment companies pay at least modest dividends to shareholders, as a thank-you for investing and an incentive to continue. They make use of dividend income received from the underlying companies in the portfolio, but some have the option of drawing on capital too.

Importantly, boards don’t have to pay out all the income they receive each year. They are allowed to withhold up to 15%, enabling them to build reserves from which they can top-up dividends in lean years.

What’s the difference between final and interim dividends?

Final dividends are paid once a year after the investment company reports its full-year financial results. Normally they are recommended by the investment company’s board but have to be approved by shareholders at the AGM.

Interim dividends can be paid at any point in the financial year – reflecting the past three or six months, say – and are normally approved and declared by the board.

What do ex-dividend and cum dividend mean?

Each time an investment company declares its dividend (known as the declaration date), it specifies an ex-dividend (ex-div or XD) date a few weeks ahead. This is the cut-off point after which anyone who buys shares won’t receive the most recent dividend. Usually the share price will then fall by the value of the dividend to reflect the fact that it is ex-dividend.

If you buy shares ‘cum dividend’, that simply means you’ve bought them in the window after the dividend has been declared but before that cut-off point, and are therefore eligible for the dividend payment.

To get the dividend, the latest you can buy the shares is the day before the XD date, not on it. Conversely, if you’re planning to sell your shares but still want to receive the latest dividend, you need to hold onto them until at least the XD date.

Why does payment take so long?

The declaration also includes a payment date, and this can be a month or more after the ex-dividend date – so two months (or more) after the dividend was actually declared.

The timing is dependent on the structure of the investment company and the date of the AGM, when the final dividend payment must be approved by shareholders. But in most cases boards stick to more or less the same timing each year, so you should be able count on regular payments.

Why don’t investment companies all pay with the same frequency?

Some investment companies pay annually; others pay six-monthly, but an increasing number pay quarterly. There has been a shift towards more frequent distributions in recent years: the AIC says 57% of its income-paying members are distributing quarterly in 2021, up from 46% in 2017. Only eight pay monthly, and they are all specialist alternative trusts.

The trend towards quarterly payments may reflect the increasing importance of investment income for investors (most obviously for retirees drawing an income from their invested pensions).

Andrew McHattie, publisher of the Investment Trust Newsletter, points out that technology and the growth of investment platforms have also made distributions easier to administer.

What are special dividends?

A trust may have additional income to distribute on a one-off basis, known as a special dividend or ‘special’ and paid as well as the regular payouts. This might be a result of various things, says McHattie: “A special event, some sort of windfall, or just unusual circumstances that mean underlying portfolio holdings are paying special dividends to the trust.” 

“Some trusts, such as GCP Asset Backed Income (GABI) and Chelverton UK Dividend Trust (SDV), have stated policies relating to special dividends, where they target a steady base or core dividend and pay a variable ‘special’ on top,” he adds.

What happens with dollar-denominated dividends?

British investors have no need to be scared off by dividends paid in US dollars, says McHattie. 

“Modern online brokers simply convert them to sterling for payment into your account as usual, although of course there is some currency risk.”