‘Dividend hero’ City of London (CTY ) investment trust is relying on another increase in its payout to keep investors sweet after underperforming in its last financial year. 

In the year to 30 June the 5%-yielder grew total net asset value (NAV), including quarterly dividends, by 4.5% and its shares returned 4.1%, trailing the FTSE All-Share’s 7.9% total return.

However, the Janus Henderson flagship increased the dividend per share to 20.1p up from 19.6p last year, marking a record 57th consecutive year of dividend increases. 

Earnings per share covered the dividend, but declined 2.8% to 20.14p per share over the period as mining companies Rio Tinto (RIO), BHP (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 was suffering compared to overseas markets 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 the UK’s attractive dividend-paying stocks. 

‘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 benefited 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 received a bid earlier this month. 

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

Investor demand for the reliable dividend grower is evident in the trust’s premium rating with its shares trading 1% above the underlying NAV in conrast to its sector where trusts on average trade at a discount of 4.3% below asset value - and wider discounts across investment companies in general – which allowed it to issue £153m share over the 12-month period.

JPMorgan Cazenove analyst Christopher Brown noted that private investors own more than half the shares, 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%, and a ‘competitive’ 0.37% fee, there were better opportunities across sector peers trading at double-digit discounts.  

Portfolio positioning

Speaking to the media after the results, Curtis pointed out that the travel and leisure stocks were the biggest detractor to performance as he had missed the sector’s recovery by remained underweight an area that had seen many companies cut dividends after Covid pandemic.

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 fund manager 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 is in blue-chip FTSE 100 companies, with a 10% weighting to smaller UK listed companies, while 15% are listed overseas.

Gearing, or borrowing of just over 6%, was the largest contributor to performance over the period as the value of the trust’s debt declined and weighed less on the NAV.

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. 

As of 21 September, City of London shares had generated a 51.6% total return over three years, just ahead of their All-Share benchmark’s 43% and their sector average of 41.9%.