Investment trusts for income

For advisers working with clients in need of income, the months ahead have some headaches in store.

First, the Bank of England is likely to cut interest rates in the coming months; it certainly seems likely that deposit rates have peaked for the foreseeable future. A second problem is the imminent cut to the dividend allowance: from 6 April, investors will pay tax on annual dividend income above £500, down from £1,000 in the current tax year – and £2,000 in 2022-23.

The combination of these shifts means that many advisers will want to prioritise income-generating collective funds as they help clients decide how to use their £20,000 individual savings account (ISA) allowance for 2023-24. The right fund could offer a more attractive dividend yield than cash, as well as the potential for capital growth to provide some inflation protection. And inside an ISA, that income will be tax-free, whatever its value.

In which case, investment trusts should be on advisers’ lists. The sector’s challenges have generated a great deal of coverage in recent weeks – the fact that shares in so many funds have slipped to wider discounts to the value of their underlying assets will no doubt give advisers pause for thought. Nevertheless, the advantages of investment trusts, particularly in an income context, remain intact.

Above all, investment trusts retain their ability to pay consistent levels of income, even during periods of market volatility, which will be highly prized by many investors. Remember, investment trusts are entitled to hold back up to 15% of the dividend income generated by their portfolios each year; these reserves can be used to fund payouts to investors in tough times. Indeed, investment trusts even have the option of funding distributions from capital, assuming shareholders have given their consent to this.

It is these features that have underpinned the steady expansion in recent years of the group of investment trusts that the AIC describes as its dividend heroes. These are the 20 funds that have raised their dividends every year for at least the past 20 years; indeed, half the cohort has a track record of dividend increases going back at least 50 years.

Investment trusts come with other benefits too. They can take on gearing, which will drive superior returns in a rising market; they have a governance structure that requires independent directors to serve investors’ best interests; and they operate with fixed pools of capital, which makes them well suited to investing in less liquid asset classes (some of which, like infrastructure, say, are good potential sources of income right now).

Interestingly, we are now beginning to see some early evidence of a shift in sentiment towards investment trusts. A recent survey from Research in Finance, for example, found that 33% of investors with existing holdings in investment trusts intend to increase their exposure in the next six months; only 9% plan to downsize. It also noted an increase in enthusiasm for the sector.

For advisers with a few weeks of the tax year left – and planning for 2024-25 – investment trusts won’t be the answer to all their questions. But it would be a mistake in the current market environment not to at least consider some of the benefits that the sector has to offer.