How the dividend heroes stay the course

The Association of Investment Companies chose a good moment to release its latest list of dividend heroes. These are the investment trusts that have raised their dividends every year for at least 20 years’ running; that record looks even more attractive with the Bank of England’s Monetary Policy Committee keeping interest rates on hold last week while many economists say rate cuts are inevitable this year.

In total, 20 investment trusts now qualify for dividend hero status, with Murray International Trust becoming the latest fund to join the ranking (last year’s list was also 20-strong, but two of its constituents, Alliance and Witan, have since merged to form Alliance Witan).

Half the trusts on the list have raised their dividends every year for at least 50 years. At the top of the list, City of London Investment Trust, Bankers Investment Trust and Alliance Witan all have a track record of dividend rises going back 58 years, with Caledonia Investments, on 57 years, close behind.

It's also worth noting that more than 30 funds currently have a record of raising dividends every year for between 10 and 19 years. These investment trusts are closing in on Dividend Hero status too.

How do investment trusts manage to raise pay-outs to shareholders through thick and thin? That answer lies in the unique structure of trusts, which has helped the dividend heroes to ride out challenges ranging from the oil price shock to the global financial crisis to the Covid-19 pandemic.

Critically, an investment trust is entitled to hold back 15% of the income it earns on its portfolio of investments each year; this money is retained in a dividend reserve fund that can be used to support distributions in years when the portfolio generates less income. In addition, investment trusts are allowed to make income distributions financed by capital gains on their portfolios; again, this can help protect income in more challenging times.

Among collective investment vehicles, only investment trusts are permitted to operate in this way. This is why other types of funds can’t match their long-term record of maintaining dividend increases.

Now, it’s important to recognise that consistent dividend increases do not necessarily lead to high levels of yield. In fact, in this year’s ranking, only eight of the 20 investment trusts featured currently yield more than 4.5% a year, equal to the Bank of England’s base rate. You won’t necessarily earn more income, at least in terms of yield, from an investment trust – even a dividend hero – than from a different type of collective fund, or from a cash savings account at a bank or building society.

However, in addition to your dividend payments, you also have the potential to benefit from capital growth. Investment trusts have a strong long-term record in this regard. And some funds do offer outsized yields, if that’s your goal; at the top end, Value and Indexed Property Income and abrdn Equity Income Trust both offer yields of more than 7% right now.

Still, the broader picture here, particularly in the context of a tough environment for savers and investors focused on income, is that investment trusts can provide a smooth flow of dependable income. What you’re getting from the dividend heroes is far greater certainty about your likely future income, particularly in cash terms. There can be no guarantees, but the long track records of higher dividends at these funds offers tremendous reassurance.

One final thought. Remember that all the dividend heroes are eligible holdings for your annual individual savings account (ISA) allowance of £20,000. That’s an opportunity to protect your income from tax – as well as to ensure you won’t have any tax to pay on future capital gains either. Food for thought with just a couple of weeks to go before the 2024-25 tax year ends on 5 April.