Questor: UK plc’s dividends could fall by 30pc – this is why investment trusts won’t follow suit

Questor investment trust bargains: we can expect income trusts to repeat their feat of the financial crisis, when only one cut its divi

Richard Evans 2 April 2020 • 6:00am

Many readers, Questor is sure, will own “equity income” investment trusts: those that hold dividend-paying shares that enable the trusts themselves to pay generous divis.

The advantages of such funds over conventional, “open-ended” funds are well known. They include the ability to hold smaller, less liquid stocks, the opportunity to borrow to enhance returns – and, crucially, the ability to hold back some of the income they receive in dividends from their holdings.

These reserves can be used to top up the income received from trusts’ holdings in any year when the latter fall short – which is exactly what we can expect now, thanks to the economic shutdown brought about by coronavirus.

But for how long could equity income trusts maintain existing dividends if their own income were decimated by the epidemic?

Analysts at Investec, the bank, have been doing the calculations. In particular, they looked at how UK equity income investment trusts would fare if their own dividend income fell by 30pc this year; this, Investec said, was the figure implied by the “futures” market.

Law Debenture, tipped here in May last year, is very well placed. Last year’s dividend of 26p was more than covered by earnings of 30.7p. A 30pc cut to the latter figure would take it to 21.5p, while this year’s dividend would be 26.8p if it rose by 3pc, as Investec assumed in all cases. The shortfall of 5.3p per share could easily be met by reserves of 33.4p, as at the end of last year. The remaining reserve of 28.1p would represent 105pc of the increased dividend payment.

Using that last figure as our yardstick, the next most robust trust in terms of dividend sustainability is JP Morgan Claverhouse (not so far tipped by the column), whose reserves would cover 88pc of an annual dividend even after the use of the reserves to cover a shortfall in this year’s dividend brought about by a 30pc loss of income and a 3pc rise in the trust’s divi.

Schroder Income Growth, part of Questor’s Income Portfolio, scores 76pc on the same basis, while BMO Capital & Income scores 72pc.

In descending order the other UK equity income trusts achieve the following figures: Edinburgh (64pc; tipped here on several occasions); Dunedin Income Growth (59pc); Aberdeen Standard Equity Income (57pc; tipped by Questor in June 2017 under its previous name of Standard Life Equity Income); Finsbury Growth & Income (55pc); Murray Income (49pc); Invesco Income Growth (43pc; also in our Income Portfolio); Lowland (40pc; another Income Portfolio member); Temple Bar (also 40pc; tipped in November last year); Diverse Income (38pc); City of London (28pc; tipped two years ago); Merchants (24pc; recommended here last month); Perpetual Income & Growth (23pc); and Troy Income & Growth (12pc; tipped in November 2017).

The analysts went further and calculated the effects of a second consecutive year of 30pc falls in income, as well as a rise in trusts’ divis of 3pc. Remarkably, the reserves of eight of the trusts would still be sufficient to cover the resultant shortfall, although they would be left, in Investec’s words, “rather threadbare”.

But Law Debenture would have enough left, after those two years of 30pc income falls, to cover more than half the annual dividend, while JP Morgan Claverhouse would have about a third.

The bank added: “We take comfort from the experience of the UK equity investment companies during the global financial crisis, when 11 of 14 investment companies actually increased dividends. Finsbury Growth & Income was the only one to cut its dividend, and this was by just 7pc.”

“Most notably, JP Morgan Claverhouse was able to increase its dividend by 7pc, despite a 36pc fall in earnings. Lowland held its dividend for one year, following a 29pc cut in earnings, while Dunedin Income Growth froze its dividend for two years following a 32pc fall in earnings.”