Trusts’ dividend reserves ‘no panacea’

Trusts’ dividend reserves ‘no panacea’

Investors believing closed-ended funds’ revenue reserves will protect them from dividend cuts risk getting caught out by widening discounts, Charles Stanley’s Stephen Peters has suggested.

With conditions deteriorating for UK large-cap firms, fears have emerged that 2016 could herald a series of fresh dividend cuts, with Capita Asset Services warning the outlook for payouts had “darkened markedly” compared with 2015.

While open-ended funds may struggle to generate an income in a year potentially dominated by dividend cuts, trusts have been seen as one solution because of their ability to use revenue reserves to maintain their payouts.

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Mr Peters, an investment trust analyst at Charles Stanley, did not dispute that the products may have an advantage over their open-ended peers, but warned investors to consider the wider risks of choosing the closed-ended world.

“I don’t agree that reserve revenues are the panacea to the problem [of dividend cuts],” Mr Peters said.

“With discounts narrow, do investors go into the sector to protect against dividend cuts and then get hit by widening discounts?

“Discount widening is a fact of investment trust life – just one people have forgotten about in recent years.”

Panmure investment funds analyst Charles Murphy warned that while revenue reserves were useful, they could not “solve everything”.

He said revenue reserves “represent the dividend’s rainy day fund – storing a little each year in the good times allows boards to maintain and grow dividends when life is a bit lean”.

Mr Murphy added: “The caveat to all that is if you are dependent on reserves for around 50 per cent of your dividend, then the fund’s payout and the portfolio’s earning capacity is fundamentally out of sync.

“Revenue reserves allow the profits cycle to be managed but they don’t solve everything.”

But not all sector analysts share such strong concerns.

Charles Cade, head of investment companies research for Numis Securities, said: “Revenue reserves mean the dividends of UK equity investment companies are far more secure than for their open-ended equivalents. So the managers have greater freedom to run the portfolios on the basis of total return, rather than chasing yield.

“In an environment of dividend cuts, investors will be keener to buy or hold investments that can still maintain or grow their dividends, and so we expect the equity income investment firms to remain in favour.”

Canaccord Genuity’s Alan Brierley noted that trusts’ ability to smooth dividend payouts was best highlighted during the financial crash. “Only one company cut its dividend, and that was by only 7 per cent,” he said.

Last November a research note from Mr Brierley argued that revenue reserves gave trusts an inherent advantage over their open-ended rivals.

“By retaining income during more buoyant periods, closed-ended funds can build up reserves, which can then be used to smooth out dividends in more challenging conditions. This has enabled these companies to build up an unparalleled record of progressive dividends,” he said.