Investment companies offer a unique combination of features that can make them particularly suitable for income-seeking investors:
- Dividend smoothing. Open-ended funds are required to pay out all the income they receive from their portfolio every year. Investment companies can reserve up to 15% of their income, which enables them to hold back some income in good years to pay it out in leaner ones. This has led to some investment companies, known as ‘dividend heroes’, being able to increase their dividends for as many as 50 years in a row.
- Gearing. The ability to borrow to invest means that some investment companies are able to pay a higher income.
- Access to a wider range of investments. Investment companies can invest in a wide range of assets, including illiquid assets. Assets like commercial property, infrastructure and renewable energy, as well as some specialist kinds of debt, can all offer a higher income than conventional equities and bonds.
- Paying dividends out of capital profits. Investment companies are not restricted to paying dividends only from the income they receive from investments. They can also use the profits they make when they buy and sell investments. Only a handful of mainstream investment companies take advantage of this ability, although Venture Capital Trusts (VCTs) use it widely.
- Inflation-beating income. Many income-paying investment companies have a mandate to increase dividends at least in line with inflation. The average investment company in the AIC UK Equity Income sector has, over the last five years, produced dividends growing at a compounded 3.95% a year, compared to CPI inflation of 3.1% (as at 21/10/21).
Investment companies are equities, whatever the nature of the underlying investments. This means they are unsuitable for clients who cannot bear the risk of capital loss.
Income-producing investment companies may be particularly suitable for clients who can tolerate capital volatility, but want an income that is more consistent and/or higher than conventional equity or bond markets can offer, as well as the potential for capital growth over the long term.