It’s reasonable to expect that investors looking for income prefer consistency. For those investing in shares instead of bonds, this isn’t always straightforward.
After looking at discounts and premiums in the first part of our investment trust series, we’re now looking at whether investment trusts can provide reliable income and some of the advantages they have over open-ended funds.
Do investment trust discounts matter?
This article isn’t personal advice. All investments and any income from them can rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future. If you’re not sure an investment is right for you, ask for financial advice.
Why investment trusts can deliver more reliable income than funds
When a company pays a dividend, open-ended funds and investment trusts have different rules on what the manager can do with that income.
In an open-ended fund, the manager has to either distribute the cash to investors or reinvest it in the fund. Investment trusts are different. Managers can put up to 15% of their dividends to one side for a rainy day. For investors seeking a consistent annual income, this brings advantages.
By putting aside some of the dividends in years when income is higher, investment trusts build up revenue reserves. These reserves can be used to top up the income received from companies in future years, so distributions to investors remain stable.
During times of economic uncertainty, companies may be less willing or able to return cash to shareholders.
This was the case during the pandemic. In the second quarter of 2020, dividend payments by UK companies fell by more than half compared to the year before.
This meant that many funds had to reduce the distributions that they made to investors. But investment trusts were able to draw on built-up reserves to maintain, or even increase, their dividends.
Research from the Association of Investment Companies (AIC) found that 85% of income-paying trusts maintained or increased their dividends in 2020, compared to less than a quarter of open-ended funds.
How revenue reserves help maintain dividends
Investment trusts provide details on the income they pay in their annual reports. They also detail whether the trust’s dividend was covered by company dividends or whether reserves were used to supplement this income. Information on the level of revenue reserves is also available.
The AIC even highlights ‘dividend heroes’ – trusts which have increased dividends annually for at least 20 consecutive years. With the last 20 years spanning both the Global Financial Crisis and the Covid-19 pandemic, the number of trusts retaining their dividend hero status highlights the benefit of storing some dividends to provide reliability for investors at a later date.
3 investment trusts focused on income
Here are three investment trusts focusing on income. But remember, yields and income are not guaranteed and will change over time.
Investing in these trusts isn’t right for everyone. Investors should invest only if the trust’s objectives align with their own and there’s a specific need for the type of investment being made. You should understand the specific risks of a trust before investing and make sure that any new investment forms part of a diversified portfolio.
Investors in closed-ended funds should be aware the trust can trade at a discount or premium to its net asset value (NAV). All three of these investment trusts can use gearing (borrowing to invest), which magnifies both gains and losses and, therefore, increases risk.
Scottish American Investment Company
The Scottish American Investment Company is one of the oldest investment trusts around.
The managers aim to grow both capital and income by investing in company shares, but the trust also invests in other assets like bonds, infrastructure, and property. The trust has increased its dividend for 52 consecutive years.
James Dow is the lead manager. He joined Baillie Gifford as a graduate and has been involved with the trust since 2016. Dow is supported by deputy manager Ross Mathison and a dedicated team of five analysts. He can also call on the wider resource at Baillie Gifford.
The trust invests in some higher risk areas of the market, like emerging markets and high-yield bonds. The managers can also use derivatives, which increase risk.
City of London Investment Trust
City of London Investment Trust aims to provide long-term growth in income and capital by investing mainly in large UK companies.
The trust invests mainly in good-quality, well-managed companies, which can be bought at a reasonable share price. It’s also an AIC ‘dividend hero’, having increased its dividend for a record 60 consecutive years.
Job Curtis is an experienced UK equity income investor and has managed the trust since 1991. Curtis receives support from deputy manager David Smith, and the duo have worked together for several years.
The managers may invest in smaller companies and use derivatives, both of which increase risk. Charges are taken from capital, which can increase income but reduces the potential for capital growth.
JPM Emerging Markets Growth & Income
JPMorgan Emerging Markets Growth & Income aims to grow your investment over the long term by investing in growing businesses across a diverse range of emerging economies like India, China, and Taiwan. Keep in mind that emerging markets are higher risk and typically more volatile than developed markets.
Seasoned investor Austin Forey has managed the trust since 1994. He’s supported by co-manager John Citron, with the duo able to draw on research from more than 100 analysts around the world.
The trust recently adopted an enhanced dividend policy, saying that it will pay out annual dividends equal to 4% of the previous year’s NAV. The trust doesn’t invest much in companies paying this level of income, so revenue and capital reserves are used to top up distributions to investors.
Paying income from capital means that the trust may have to sell assets to fund dividends, which reduces the prospect of future capital growth.
Annual percentage growth
July 2021 to July 2022 | July 2022 to July 2023 | July 2023 to July 2024 | July 2024 to July 2025 | July 2025 to July 2026 | |
|---|---|---|---|---|---|
Scottish American Investment Company | 2.43% | 7.41% | 4.21% | -0.48% | 10.92% |
AIC Global Equity Income | -4.11% | 0.12% | 14.53% | 9.42% | -1.33% |
City of London Investment Trust | 10.09% | 3.08% | 16.73% | 16.39% | 24.46% |
AIC UK Equity Income | -6.11% | 4.50% | 13.75% | 11.36% | 19.24% |
JPM Emerging Markets Growth & Income | -13.96% | 0.83% | 3.92% | 11.99% | 40.40% |
AIC Global Emerging Markets | -5.76% | 10.09% | 10.74% | 22.54% | 32.97% |