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Holding out for a hero

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31 July 2020

With dividend income under so much pressure, David Prosser discusses investment company dividend heroes and the UK Equity Income sector.

Congratulations to City of London Investment Trust, which has just announced that it its dividend payment for the year ended 30 June will be 2.2% up on last year – the 54th successive year in which the fund has raised its pay-out. The investment company has also promised that next year’s dividend will be higher too, taking it to 55 years in a row.

City of London is one of a clutch of investment companies sitting at the top of the Association of Investment Companies’ Dividend Heroes ranking of funds that have raised their dividends in each and every year for at least two decades. Three others – Bankers, Alliance and Caledonia Investments – also have a 50-year-plus track record. They’ve maintained this impressive run by making good use of investment companies’ unique ability to build up dividend reserves – keeping back some of the income they earn on investments in bumper years in order to bolster pay-outs to shareholders in tougher times.

City of London makes no secret of the importance of this feature. There has been concern in recent months that the way in which UK companies have been slashing dividends in response to the Covid-19 pandemic would mean the fund’s proud run might come to an end. But the investment company wrote to shareholders in April to assure them that if needed, it would be able to dip into its reserves this year to pay a higher dividend; the reserves are also healthy enough for it to be confident enough to promise an increase next year too.

This select club of investment companies that have been raising dividends since the 1960s understandably attract lots of attention. But what is not always realised is that they represent the public face of a broader phenomenon. Indeed, while City of London’s long-term record of consistent dividend increases is remarkable, plenty of other funds have matched or exceeded its generosity in recent years.

Looking at the UK Equity Income sector, the average fund raised its dividend by 5.63% a year over the five years to 30 June. And almost every fund in the sector with a five-year track record can point to a positive average annual dividend increase over the period.

Remember, these increases have been paid during a time when savers and investors in the UK have generally been starved of income. Interest rates on most bank and building society accounts were below 1% for the whole of that period. Bond yields were at or close to record lows.

Of course, investors who opted to put money into a UK Equity Income fund instead had to accept the risk of capital losses – unlike cash savings, share prices can fall as well as rise. But actually, over the five years to 30 June, the average fund in the sector delivered a return of 15.5%; over 10 years, by the way, that average rose to 137%, with not a single UK Equity Income fund recording a loss for its investors.

In other words, investors have been rewarded for taking risk – sometimes handsomely so. But for those looking for income, that hasn’t really been the point of the exercise. The capital profits they have made – or, indeed, the losses where relevant – are almost incidental. What these funds have offered is precious income that has been tough to find elsewhere. And while the climate for income is now even tougher, with dividend income under so much pressure during the pandemic, these investment companies continue to offer shelter from the storm.