Heroic returns

David Prosser examines our latest dividend hero list and discusses the advantages investment companies have when it comes to paying income.

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IIt’s difficult not to feel a bit sorry for Caledonia Investment Trust. Despite increasing its annual dividend to investors in each and every year for the past 51 years, the closed-ended fund doesn’t even make the podium in the latest Association of Investment Company “Dividend Heroes” ranking. City of London, Bankers Trust and Alliance Trust have pipped it to the post, having extended their record of annual dividend increases to 52 years.

In all, the AIC’s dividend heroes – funds increasing their dividend for at least 20 consecutive years – now number 20 investment companies. But while each of them clearly has an impressive record of income distribution, a couple of other things are striking about the list.

First, it is clear that it would be possible to build an international diversified portfolio of fund-holdings from the dividend heroes. Half of them are to be found in the UK Equity Income sector, but for those investors looking to go beyond domestic stock market exposure, there are nine Global and Global Equity income funds to consider too. Caledonia, meanwhile, falls into the Flexible Investment Sector.

Within this universe, moreover, there is no shortage of different types of investment strategy. From the small-cap bias of BMO Global Smaller Companies to the technology company bias of Scottish Mortgage, there is plenty to interest advisers and investors focused on well-mixed asset allocation.

The second stand-out from the AIC’s ranking is the column providing yield data. Some of the funds in the ranking certainly do offer very high yields – 18.1 per cent at British & American, for example, 5.4 per cent at Merchants, and 4.5 per cent at Value & Income. Others, however, offer less – as little as 0.6 per cent at Scottish Mortgage, and less than 2 per cent at Alliance, Caledonia, BMO Global Smaller Companies and F&C Investment Trust.

Herein lies an important point. Income-oriented investors very often aren’t seeking the highest pay-outs in absolute terms. Rather, what they want is consistency and reliability – the certainty their income will arrive each year (or every six months or even quarterly, depending on the fund).

This, of course, is where investment companies come into their own. The reason it is possible to build a list of funds that have kept on raising dividends over such remarkably long periods is that investment companies have a structural advantage over other vehicles. Only a closed-ended fund has the right to build up income reserves, retaining income in stronger earning years in order to fund pay-outs – and increases – during weaker periods.

For investors worried about the sustainability of dividends, moreover, an investment company’s dividend cover statistics provides a transparent view of how long it would be able to sustain pay-outs at current levels from its current reserves alone. This information, available from sources such as the AIC website, is a valuable metric for investors and advisers planning a strategy for medium- to long-term income generation.

In practice, demand for consistent income-paying funds is only going to increase. It’s not just that the interest rate environment requires income seekers to look beyond cash assets, but also that more and more investors are looking for income-producers to hold in pension funds as part of a drawdowns strategy. Closed-ended funds such as the Dividend Heroes, look set to play a crucial role in meeting this demand.