The quest for income

With income ever harder to find in the current market environment, investors in some investment trusts may have good reason to thank the former Chancellor, George Osborne, for what seemed at the time to be an obscure reform to the tax laws governing investment companies. Four years ago, Mr Osborne’s tinkering allowed, for the first time, investment companies to draw on the capital growth they achieve in order to fund income payments to investors.

“A tax change in 2012 allowed investment trust companies to pay out realised profits as income,” explains Simon Elliott, an analyst at Winterflood Investment Trusts. “The possibility of converting capital into income was initially regarded with suspicion but there now appears to be acknowledgement that this is another advantage that the closed-ended fund structure provides.”

As Elliott hints, the idea of funding income out of growth is potentially controversial. Equity investors understand that reinvesting their dividends can soup up capital returns, particularly over the long term, but drawing on capital to finance dividends could have the opposite effect.

Nevertheless, for investors whose primary focus is on income – and who understand the potential trade-off they may be making – the income-from-capital approach may be attractive. In fact, a number of investment companies have already sought permission from shareholders to take advantage of the change in the law, often to good effect.

One attraction of the reform is that it enables funds to maintain their yields without making substantive changes to their investment policies – they don’t have to go chasing income, in other words. Personal Assets Investment Trust, for example, has adopted the measure precisely so it doesn’t have to compromise its investment approach. Securities Trust of Scotland has said it will look to enhance its natural dividends from capital so that its yield remains in line with what is available from its sector peers. Invesco Perpetual UK Smaller Companies has made similar moves.

The latest investment company proposing to adopt this measure is JPM Global Growth & Income, a strong performer that wants to broaden its appeal by increasing its yield without changing its underlying investment rationale. Others are likely to follow.

Clearly, there’s a balance to strike. Funds that cannibalise too much growth in order to underpin income distributions will pay a price over time, to the detriment of their investors. But a carefully managed income policy can provide the yields investors are looking for without requiring the fund to make investments it would otherwise eschew.

At Winterflood, Elliott thinks JPM Global Growth & Income’s proposals are likely to find favour with investors. “We believe that the proposals are well‐considered and offer investors a chance to have their cake and eat it by providing access to a successful growth manager and an attractive yield,” he argues.

Investors and advisers won’t want to see investment companies moving to this approach willy-nilly, but will feel comfortable trusting well-managed funds with a strong track record to find the right balance. More broadly, the fact this is even an option for investment companies – unlike other types of collective fund – is another reminder that the sector offers some unique advantages.