Trusts to cope with equity earnings drop

The study warned managers seeking income could be vulnerable to “a more challenging environment” for earnings and dividend growth next year, with open-ended funds particularly exposed.

According to analysis by the broker, UK large caps are currently yielding around 4 per cent but their total net income has dropped from £171bn to £138bn in the past five years.

Dividend cover fell from 2.7x to 1.6x over the same period, Canaccord investment trust research director Alan Brierley noted, with high-profile firms such as Tesco, Serco, Glencore, Drax and Centrica having cut dividends more recently.

Mr Brierley also highlighted a “UK earnings downgrade epidemic”, asserting some 51 per cent of UK large caps have seen 2015 earnings forecasts downgraded in the past three months, while only 22 per cent have been upgraded.

In light of these downgrades, the broker claimed the closed-ended sector may fare better in these conditions, in part because of trusts’ dividend covers and revenue reserves.

Mr Brierley said: “The closed-ended structure gives managers competitive advantages, including an ability to manage volatility in underlying dividend streams.

“This was best evidenced during the global financial crisis, when only one investment company cut its dividend. We believe the open-ended equity income fund sector is much more vulnerable if recent dividend cuts in the equity market gather momentum.”

According to the report, for example, the JPMorgan Claverhouse trust has revenue reserves equivalent to 16 months of its last annual dividend, followed by the Dunedin Income Growth trust with 12.2 months’ worth of reserves, BlackRock Income & Growth with 12 months and Temple Bar with 10.7 months.

Similarly, Canaccord estimates the Diverse Income Trust had dividend cover of 123 per cent in the last financial year, followed by the Standard Life Equity Income and JPMorgan Claverhouse vehicles, which each had cover of 117 per cent.

Returning to stocks, Canaccord said a number of large-cap dividend yields now appear to be at, or nearing, unsustainable levels.

Mr Brierley noted metals and mining giant BHP Billiton offered a dividend yield of 7.6 per cent and Royal Dutch Shell had a dividend yield of 6.9 per cent. Meanwhile, fellow oil major BP had a yield of 6.5 per cent and pharmaceuticals company GlaxoSmithKline yielded 6.6 per cent.

One stockpicker to have cut Glaxo from his portfolio in recent months is Mark Barnett, manager of portfolios including the Edinburgh Investment Trust.

Mr Barnett once numbered the drugs firm among his top holdings, but said last week he had jettisoned the stock. The Invesco Perpetual manager also echoed Mr Brierley’s concerns over the outlook for the UK market more broadly.

He said: “The UK stockmarket [has become] a more volatile place to invest. However, this is also an environment that favours active portfolio management. In the near term the outlook may indeed be more challenging as profit warnings and dividend cuts become a recurring feature of the landscape. The successful manager will need to tread carefully in this environment in order to avoid these pitfalls.”