City of London (CTY ) investment trust is relying on its increasing dividend to keep investors sweet as it has underperformed in its last fiscal year. 

The 5%-yielder underperformed in the year to the end of June, with net asset value per share increasing 4.5% and the share price, 4.1%, versus the FTSE All-Share index benchmark’s 7.9%. However, CTY increased the dividend per share to 20.1p up from 19.6p last year, marking the 57th consecutive year of dividend increases. 

Earnings per share covered the dividend, but declined 2.8% to 20.14p over the period as mining companies, Rio Tinto (RIO), BHP and Anglo American (AAL), stopped paying special dividends, which had driven a 21.2% increase in revenue earnings the previous year.

Writing in annual results, chair Laurie Magnus acknowledged the UK market is suffereing compared to overseas peers because of investor scepticism over the benefits of Brexit, the high number of value stocks, the lack of domestic investment in equities and the prospect of a more interventionist Labour government.

However, he sought to reassure investors by drawing attention to dividends. 

‘It remains the case that UK equities offer compelling dividend yields relative to the main alternative equity markets and, on this basis, UK investors can reasonably take the view that they are being ‘paid to hold on’ until valuations improve,’ Magnus wrote. 

The £2bn UK equity income trust has also benefitted in some ways from these low valuations. Private equity firms and foreign companies have started looking to buy cheap companies, such as song royalties trust Round Hill Music Royalty (RHM ),  which recieved a bid earlier this month. 

Manager of the trust Job Curtis (pictured) added RHM to the portfolio in June.

Investor demand for income is evident in the trust’s share price premium rating of 0.5% versus the sector’s average discount of 4.3% - and wider discounts across investment trusts in general – which allowed it to issue £153m share over the 12 months to the end of June.

JPMorgan Cazenove analyst Chris Brown noted that retail investors own over half the trust, with investment platforms Hargreaves Lansdown, Interactive Investor, Halifax Share Dealing, AJ Bell and Fidelity making up a combined 52% of the shareholder register.

He added that while the trust offers a dividend yield above the sector average, index-beating five-year shareholder returns of 25%, a ‘competitive’ 0.37% fee, there were better opportunities across sector peers trading at double-digit discounts.  

Portfolio positioning

Speaking at a media breakfast, Curtis pointed out that the travel and leisure sector was the biggest detractor to performance, which he had remained light since the Covid pandemic when many companies had cut their dividends.

Insurance company Direct Line (DLG) was the worst-performing individual company after issuing a profit warning at the beginning of the year because policy premium income had not been keeping pace with rising claims inflation. The company has also stopped its payouts for now.

Curtis noted that major insurance reprices every year, meaning it has good recovery prospects. In fact another holding, German insurer Munich Re, was the second biggest contributor to performance. 

He added that there are ‘some extraordinarily cheap, attractive yields within life insurance and financial services stocks’, pointing to M&G (MNG), ‘which had results yesterday on 9% yield up but its dividend is up by 4%, as well as Phoenix (PHNX) and Legal & General (LGEN).’

Three quarters of the portfolio are FTSE 100-listed companies, with a 10% weighting to smaller UK listed companies, while 15% are listed overseas.

Gearing, which was the largest contributor to performance over the period as the value of the debt declined, sits at 6.2%.

Curtis added that the trust’s undrawn £120m borrowing facility with HSBC could push gearing up by another 6% and could be deployed when he feels more confident about market prospects.