Investment companies: Structured for income

A view from David Prosser, former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine.

Another month, another base rate freeze from the Bank of England’s Monetary Policy Committee, which has now kept interest rates at just 0.5 per cent for an astonishing five years. And while there is mounting speculation that rates may finally begin to rise towards the end of this year or in 2015, there is no immediate prospect of an increase.

For income seekers, the outlook remains bleak – particularly in the savings account industry where few accounts now pay enough interest to protect your money from the effects of inflation. In order to generate decent yield, savers must look beyond bank and building society accounts.

A proud history of paying dividends

Enter the investment trust sector, where a string of closed-ended funds have been paying consistently generous incomes for many years – decades in fact.

Take Foreign & Colonial Investment Trust, which has just announced a dividend increase for the 43rd consecutive year. That has put it on a par with Brunner Investment Trust, which announced a dividend increase last month – also for the 43rd month running. These pair aren’t even the standard bearers for the investment trust industry. That accolade is shared by City of London Investment Trust and Bankers Investment Trust. Both have raised their dividends in every one of the past 47 years.

In fact, many investment trusts have a remarkably long-term record of raising dividends. A quarter of closed-ended funds have paid higher dividends every year for at least a decade.

Structured for income

Investment trust boards and managers know well that the income they offer is often a crucial part of their allure for investors. And they have an advantage over other types of collective investment – the rules to which they are subject make it easier for them to focus on income.

One advantage is that investment trusts are able to retain 15 per cent of the income they earn each year in order to fund dividend payments to investors in times when maintaining or increasing yield might otherwise be challenging. The effect is to smooth out income payments over time, providing investors with a much more predictable flow of rising dividends.

A second plus point is that, in recent years, investment trusts have been given permission to fund income payments from capital. This facility has some useful advantages. Most obviously, if the income isn’t there in a particular year to pay dividends, the fund has the option to fund a distribution by dipping into its capital. Also, investment trusts are able to invest in assets that don’t traditionally generate much income – private equity is a good example – and still be able to pay dividends to shareholders.

Investment trusts must make it clear when they are funding income payments in this way and not all investors will be comfortable with the erosion of capital it may imply. Still, this is a useful facility.

All in all, investment trusts are an important option for income seekers comfortable with taking on more risk than they would face from, say, savings accounts. And for investors happy with exposure to the stock market, the sector has a number of crucial advantages to offer.