Go smaller for income
Trusts investing in smaller companies could be worth a look for income investors, says David Prosser.
Big companies pay more generous dividends, right? Well, not always. Received wisdom is certainly that larger businesses, likely to be more established and with fatter reserves, tend to be a better place to look for income than their smaller counterparts. But new research suggests that may not be the case over the next couple of years.
Rather, Octopus Investments predicts that by 2025, small and medium-sized listed companies in the UK – defined as those in the FTSE Small Cap and the FTSE 250 indices – will offer more generous yields than FTSE 100 businesses. In which case, this will be the first time in a decade that both indices have offered more generous income distributions, Octopus reports.
In total, the FTSE 100’s total cash dividend in 2025 will be 11% down on pre-Covid levels, Octopus’s research suggests. By contrast, cash dividends from listed companies outside the blue-chip index are on target to rise by 5%. Hence Octopus’s forecast of average dividend yields of 4.46% and 4.53% respectively next year for the FTSE 250 and the FTSE Small Cap, against 4.26% for the FTSE 100.
“Investment trusts offer an attractive route into this part of the stock market – particularly right now, with shares in many of these funds currently trading on unusually wide discounts to the value of their underlying assets.”
David Prosser
It’s an intriguing idea. In recent months, we’ve seen a growing number of investment analysts and advisers suggest that the top end of the UK stock market is not necessarily the place to be in the coming months. But such arguments largely tend to focus on the tendency of small and medium-sized companies to outperform during periods of economic recovery. Now it seems there might be a case for looking to these stocks for income as well as capital gains.
Investment trusts offer an attractive route into this part of the stock market – particularly right now, with shares in many of these funds currently trading on unusually wide discounts to the value of their underlying assets. Their closed-ended structure and specialist management teams leave them ideally placed to provide exposure to what can be a volatile, illiquid and under-researched area of the market.
From an income perspective, moreover, investment trusts come with an additional advantage. The have a unique right to retain some of the dividend income earned from portfolio companies in good years in order to subsidise payouts to investors during leaner periods. This means they can deliver the consistent levels of income that are so important to many.
In fact, three UK Smaller Companies investment trusts feature in the AIC’s Dividend Heroes list of 20 funds that have increased their dividend payouts in each of the last 20 years or more. Henderson Smaller Companies, BlackRock Smaller Companies and Athelney Trust all belong to this club. So too does The Global Smaller Companies Trust, which runs a portfolio of international smaller company stocks.
In other words, while income-focused investors might assume they need to steer clear of smaller company funds, this isn’t necessarily the case, particularly in the investment trust sector. And if small and medium-sized companies in the UK are about to take the lead on dividend payouts, there is even more reason to give this sector a closer look.
