Reserves of strength

In a week when the Bank of England’s Monetary Policy Committee disappointed many savers and investors by confounding expectations that it would raise interest rates, there was at least some good news for income seekers. Alliance Trust, the £2.3bn investment company, announced it would increase its dividend payments by almost a third this year.

Alliance, which has raised its dividend every single year for more than 50 years, is a leader in the Global sector of the investment company industry. These are funds which have rarely had an opportunity to showcase their unique talents more publicly than over the past 18 months amid the Covid-19 crisis.

Remember, investment companies, unlike other collective funds, are entitled to build up revenue reserves over periods when their portfolios earn good dividends; these reserves can then be used to support distributions to investors in leaner times. This is exactly what has happened over the past 18 months; while UK companies slashed their dividends as the pandemic hit revenues, most equity income-paying investment companies were able to maintain or even increase their own pay-outs.

The good news is that in protecting investors in this way, investment companies do not appear to have left themselves short. Alliance Trust’s dividend increase partly reflects a technical adjustment, in that it has merger reserves to draw on as well as conventional reserves, but reflects a broader pattern across the sector. Most UK equity income investment companies are still in strong enough financial health to pass on at least some of the post-pandemic dividend recovery to investors.

Research published in recent days by the analyst team at Investec confirms that conclusion. While investment companies have eaten into their revenue reserves in order to support dividends over the past 18 months, Investec argues that they have not left themselves vulnerable. “The key takeaway is that once again the revenue reserves have enabled the majority of investment companies to maintain a progressive dividend,” Investec says. “With a strong recovery in UK dividends now underway, the majority of investment companies can still demonstrate reasonable levels of revenue reserves.”

To put that another way, investment companies have provided shelter for income-seeking investors during one of the most tumultuous storms in living memory. And now sunnier times are returning, they are still in a position to pass on the good weather.

Comparisons with open-ended equity income funds, which lack the option of building revenue reserves, make sobering reading. Just two out of 16 UK Equity Income investment companies reduced their dividend during the Covid-19 crisis, while the majority of open-ended funds had no choice but to take this step; indeed, the average dividend cut last year across the UK Equity Income open-ended sector was a painful 29%.

There are no guarantees. Investment company reserves will only last so long and, as Investec points out, the recovery we have seen from UK dividends so far has been heavily dependent on one-off special dividends and a bumper round of pay-outs from the mining sector. While dividend prospects certainly look better than a year ago, it would be comforting to see a broader recovery.

Nevertheless, Alliance Trust’s 30% dividend increase – and the broader health of the investment company sector – is to be welcomed. For advisers and investors looking for reliable income over the longer term, it must surely be a first port of call.