Why investment trusts could benefit from pension freedoms

This article is part of
Income Options - November 2014

Investors are often referred to as being on the ‘hunt for income’ and with pension reforms on the horizon and the ongoing low interest rate environment, it would seem the hunt is still on.

The government’s pension shake-up means that those reaching retirement age will no longer be required to buy an annuity from next year, so many will be encouraged to seek other means of providing income while remaining invested in retirement.

The case for trusts

Article continues after advert

Investment trusts have long been lauded as income generators, as the Association of Investment Companies (AIC) verifies. Their ability to generate income through most market environments is a key feature of their growing appeal - albeit from a relatively low base in the intermediary channel.

Jemma Jackson, PR manager at the AIC, suggests: “The investment company sector has a well-earned reputation when it comes to income generation.

“The AIC publishes a list of investment company ‘dividend heroes’ each year: companies which have been able to increase their dividend each year through both the good times and the bad, through booms and bust. And while this is never guaranteed, it is nevertheless a reassuring feature for many investors.”

She notes that there are around 20 investment companies that have been increasing their dividends each year for more than 20, 30 and, in some cases, 40 years. There are countless more that have been notching up annual dividend increases for 10 years and counting, she adds.

The AIC recently published figures which show that the investment company UK Equity Income sector dividend increases beat inflation by more than 2 per cent a year over a period of 20 years.

Its figures revealed that £100,000 invested in the average UK Equity Income investment trust on September 1 1994 had generated an initial annual income of £3,265 by August 31 1995. This annual income would have climbed to an impressive £8,139 by August 31 this year.

This means that the annual income grew by an average of 5 per cent per year over 20 years, while inflation (RPI) averaged 2.9 per cent over the same period. Ian Sayers, director general of the AIC, believes that these figures make the case for investing in investment trusts at retirement.

He comments: “Of course, this type of investment is very different from buying an annuity. There are no guarantees and you are putting both your income and capital at risk. But for those who can accept the risks, these figures make a compelling case for investment companies to be considered as part of a long-term income portfolio.”

Protecting dividends

In terms of how trusts go about ‘protecting’ their dividend, Ms Jackson explains: “They can do this by squirreling away some of the income they receive each year and saving it for tougher times – such as dividend cuts from portfolio holdings – BP’s oil spill, which led to a dividend suspension, being a case in point.

“This is a unique characteristic which sets investment companies apart from other forms of collective investment.”