Weathering the storm

Newspaper headlines rarely tell you the whole story. Media coverage of the investment companies sector in recent days has been dominated by the news that “Investment trust dividends fall for the first time since 2010”. That is not inaccurate – data from Link Group does indeed show that closed-ended fund pay-outs fell during the first six months of the year – but it is hardly the full picture.

The bare facts are that with the adverse effects of Covid-19 on corporate earnings now being felt, investment company dividends totalled £891.9m during the first half of 2021, 3.1% less than in the same period of 2020. That represents the first decline seen since the second half of 2010, when the impacts of the global financial crisis filtered through to the investment companies industry.

Still, the devil is in the detail. First, it is important to note that while prominent sectors including UK Equity Income, Global and Europe all registered significant falls in dividend pay-outs, other areas of the market performed more strongly. These included both other equity funds – emerging markets funds, for example, paid out more in 2021 than in 2020 – and alternative asset-invested investment companies. In the latter category, private equity, infrastructure and renewable energy funds all delivered substantial dividend increases year-on-year.

Bear in mind too that while some investment companies have felt compelled to reduce their dividends this year, the majority have not done so. As Link Group reports, seven in ten funds either raised their pay-out or held it steady in the first half of the year.

Moreover, the most important aspect of this story is that Link’s data reveals investment companies are doing their job – delivering exactly what they promise.

Crucially, closed-ended funds have a unique ability to build up reserves, holding back some income in stronger years in order to fund dividends during periods when returns disappoint. This provides investors with a vital smoothing effect.

We can see this in the data. Link points out that between January 2020 and June 2021, UK dividends fell by 34.6% amid the Covid-19 crisis. Global dividends were down 5.9% over the same period. If investment companies had passed those cuts on, their pay-outs would have fallen around 20% over the same 18-month period; in fact, they rose 2%.

It was closed-ended funds’ reserves that enabled them to pull off this escape act. Prior to the pandemic, investment companies had combined reserves of £2.13bn; over the past 18 months, they have dipped into these accounts to the tune of £360m, with £22 of every £100 worth of dividends funded in this way. It has been a powerful illustration of the value of the concept.

Comparisons with open-ended funds emphasise the point. In 2020, 85% of equity-focused investment companies increased or maintained dividend pay-outs; only 23% of comparable open-ended funds managed it.

Reserves do not last forever, of course. But with £1.77bn still in the bank, investment companies are in a position to go on subsidising pay-outs for a little while yet – if they need to do so. They may not have to, though, since Link forecasts a dividend recovery from the wider stock market – it thinks UK companies will pay out 13.4% more this year than in 2020.

All in all, the lesson of this crisis has been that planning for a rainy day can pay off spectacularly. You might not guess it from those headlines, but the dividend performance of investment companies over the course of the pandemic has provided vital comfort to a huge number of investors.