AIC: there are dividend trailblazers among us

Our own end-of-year fund manager poll found managers overwhelmingly positive on the prospects for markets and the US more generally, notwithstanding some background concerns. Again, amid clear uncertainty, the general consensus still appears to be ‘glass half full’, especially so given the anticipated boost to US infrastructure spending.

Of course one of the key stories behind the stock markets rise has been the continued demand for income in a low interest rate environment, with investors taking a more ‘risk on’ approach in the face of limited income options elsewhere.  

While we all know that investors are hungry for yield, we don’t always think too carefully about just how important that income might be and what it means to shareholders – or indeed who those shareholders might be.  

But Bruce Stout, manager of Murray International, is in no doubt: “When I talk to our shareholders and ask what they do with their dividend, they say it goes out of their bank account and pays their gas bill. That shows me that the real dividend is very important.”  

Clearly this is something that investment company boards are increasingly realising, too, given the number of companies that have increased the regularity of their dividend payments in recent years. Last year, Association of Investment Companies (AIC) research revealed that 92 conventional investment companies now pay a quarterly dividend (43 per cent), compared to 82 by number in the previous year (32 per cent). In 2010, just 17 per cent of AIC member companies paid a quarterly dividend. There has also been a number of companies beginning to pay (usually some, not all) income out of capital, as an additional tool to give shareholders what they want: yield.

With inflation starting to creep up, I would wager that yield is going to become even more important. The AIC has used the performance of the UK Equity Income sector as an illustration of how investment companies have helped counter the effects of inflation – and how effective investment company dividends have proved in the past. 

Data from the AIC, citing Morningstar, shows that £100,000 invested into the average UK Equity Income investment company on 31 December 1996 would have generated an initial average annual income of £3,700 by 31 December 1997, which would have grown to an average annual income of £8,516 by 31 December 2016.  Annual dividend growth was 4.5 per cent, some 2 per cent ahead of inflation (annualised RPI inflation over the period is 2.78 per cent). Over 20 years investors would have received £119,872 of income from this portfolio. Meanwhile, in addition to the income generated, the capital value of the investment would have grown to £226,907 – an increase of 127 per cent – more than doubling. 

£100,000 invested in average UK Equity Income sector at 31 December 1996

Source: AIC, Morningstar

And it is by no means the UK Equity Income sector alone that has been income trailblazers. The investment company sector has a particularly strong dividend track record, with many investment companies having been able to increase their dividends each year for decades.  

This is because they have the unique ability to squirrel away some of the income they receive each year for bad times ahead. This is known as dividend smoothing and is a particularly useful feature to boost dividend payments. City of London (UK Equity Income sector) and bankers (Global sector) have each racked up 50 years of consecutive dividend increases, and if Alliance Trust and Caledonia in the Global sector announce another dividend increase this year, they will also make it into the exclusive 50-year club.

In total, some 20 investment companies have increased their dividend each year for at least 20 years, collectively notching up 742 years of dividend increases. A further 17 companies have increased their dividend each year for between 10 to 19 years.

Yields and valuations

The investment company sector is always a useful barometer of market sentiment. The impact of the UK's 23 June referendum last year on the sector's overall discount was immediate and short-term, which has since returned to near historic lows (and in any event only hit a three year low).

But clearly there are variations within the sector, and one need only compare the higher yielding, alternative asset, specialist sectors such as infrastructure and property, where premiums abound, to the more generalist sectors where discounts are more the norm.  

Again illustrating the particular demand for yield, it is the income focussed sectors which shrugged off the ‘Brexit effect’ more clearly than some of the other sectors.  The average discount in the high income yielding Property Direct: UK sector de-rated from 1.79 per cent at 31 May 2016 to 12.87 per cent at the end of June 2016, but this ‘blip’ turned out to be short lived, with the average Property Direct: UK discount closing 2016 on a 2 per cent premium.

While the ever-popular UK Equity Income sector closed last year on an albeit still modest discount of 4 per cent, it was nevertheless wider than the 2.5 per cent at the end of May 2016 (pre Brexit). Nevertheless, this discount is still significantly narrower than the average discount in the lower yielding UK All companies sector (7.8 per cent) and UK Smaller Companies (14.27 per cent) and the differential is clearly in large part a reflection of shareholder demand for income.  Indeed the UK Smaller Companies sector was one of the sectors which de rated the most last year, perhaps not surprisingly given that UK smaller companies are thought to be generally less insulated by international exposure, trading closer to 11 per cent discount pre-Brexit.

Clearly there is no telling where markets might go from here. But whatever the ups and downs, it is difficult to see the demand for income going away any time soon.  Advisers may well want to look at investment vehicles that have some structural advantages from an income point of view – and investment companies are a good place to start.

Annabel Brodie-Smith is communications director of AIC

Key points

A quarter of companies hit record share price highs in January 2017.

£100,000 invested into the average UK Equity Income investment company on 31 December 1996 would have grown to an average annual income of £8,516 by 31 December 2016.

Many investment companies have been able to increase their dividends each year for decades.