In search of inflation-beating income

In this context, the AIC’s free online data service makes it possible to search for investment trusts with a strong track record of increasing dividend payments. And a quick check on the state of play at the end of July reveals that almost 50 investment trusts boast average annualised dividend growth in excess of 10% over the past five years.

At the very top of the ranking, funds including Aurora UK Alpha, Pacific Horizon and Nippon Active Value have all delivered average annual dividend growth of more than 40%. Many others have managed dividend growth rates of 20% to 30% plus.

Investment trusts have a vital advantage when it comes to dividend distributions. Unlike other types of collective fund, they’re allowed to hold back some of the income they earn on their underlying portfolios in a given year; this money goes into a dividend reserve that can be used to support distributions to shareholders during lean periods for portfolio income.

The result is that while investment trusts may not display the most generous yields at any one time, they find it easier to build long track records of consistently attractive dividend pay-outs. Indeed, the industry is known for its dividend heroes, 20 investment trusts that have increased their dividends each and every year for at least two decades.

When inflation is elevated, this consistency becomes especially valuable. Income seekers won’t get rising payouts from fixed income assets such as bonds; cash savings accounts also struggle to keep pace. 

There’s also the question of your underlying capital. If you’re consistently withdrawing all your interest from a bank or building society account, say, the capital value of your money will remain the same. But over time, that value will be eroded by any positive rate of inflation at all. By contrast, with equities, your “total return” consists of both income and capital growth; that is, there is scope for the value of your investment to rise even when you’re banking the dividends.

There are no guarantees. Investment trust portfolios can also fall in value. And sometimes, boards and managers feel they have no choice but to hold or even to reduce dividend payouts.

Still, the breadth of the investment trust sector provides room for plenty of diversification to protect against such risk. The top ten investment trusts by five-year dividend growth at the end of July came from eight different sectors. There’s also the potential to get exposure to different asset classes – infrastructure and property, for example – which can also be reliable sources of income while often providing protection from equity market risk.

Don’t be complacent. Today’s inflation seems relatively benign compared to peaks seen in the past – including in the wake of the Covid and Ukraine crises, when it reached double digits. But even moderately elevated inflation will have an impact on the purchasing power of your income, particularly if it is sustained.

For anyone relying on investment income, it’s therefore imperative to think about whether their current portfolio is fit for purpose in this environment. And while there’s no panacea for inflation – and certainly no risk-free options – investment trusts can be a sensible way to protect yourself.