Investment trusts: how does your income grow?
You may think that the way you receive income from your investments is clear: an investment manager invests in lots of companies, they pay dividends and the manager pays those dividends back out to you.
However, this isn’t necessarily the case for investment trusts. Investment trusts can reserve income they receive in ‘fat’ years, paying it out in lean years, for example. Also, since a change to the tax rules in 2012, UK investment trusts have had the ability to pay dividends from any profits they make on buying and selling shares.
There may be good reasons for doing this: a company may want to maintain a consistent payout to shareholders, for example. Sam Cosh, manager of European Assets Trust, explains the reasons the trust pays some income from capital: “European Assets invests in smaller companies across Europe and these companies do not tend to be high dividend payers because they are growth businesses so tend not to find their way in to income seekers’ portfolios. The structure of European Assets allows the board to pay dividends from capital and by holding the trust, an income investor can diversify their own portfolio into an area that is typically not income producing.”
There can be drawbacks, however, and it may eat into investors’ capital growth.
The AIC has now introduced enhanced dividend information for each member company on its website so investors can understand how their dividends are paid. This shows the investment company’s dividend history and highlights whether each dividend was paid from income or capital.
In addition to this information, the AIC website shows the revenue reserve of all investment trusts. This is the money that a trust has set aside for a ‘rainy day’. In some cases it is worth a year or more of dividends. This should reassure investors that the payout from the trust will not be cut, even if the underlying companies cut their dividends.
The AIC is also publishing the dividend cover, which shows the number of years the current revenue reserves can last based on paying the last full financial year of dividends.
Ian Sayers, chief executive of the Association of Investment Companies, said: “Paying dividends from capital profits is an additional income advantage of investment companies. It helps meet shareholder demand for income in this low interest rate environment and potentially can lead to investment companies being re-rated to trade on lower discounts, another benefit for shareholders.”