Investment Trusts  

How do investment trusts meet income requirements?

This article is part of
Guide to Investment Trusts

How do investment trusts meet income requirements?

One of the many benefits of investment trusts is their ability to deliver a steady stream of income.

Whether it’s income to supplement the low interest rate environment the UK has been in for many years now, or income to fund retirement, there is undoubtedly a need for yield.

What many advisers and investors do not perhaps realise is that investment trusts have a longstanding reputation for delivering income year in, year out.

Dividend heroes

The Association of Investment Companies (AIC) has a list of dividend heroes – “the investment companies that have consecutively increased their dividends for 20 years or more”.

In fact, recent research from the AIC reveals 46 per cent of investment companies are now paying a quarterly dividend.

Dion Di Miceli, head of investment companies at Gravis Capital Partners, says savvy investors will be familiar with the old market adage “investment trusts for income, Oeics for capital”. 

He explains: “Firstly, investment trusts can accrue revenue reserves of up to 15 per cent of the portfolio income on an annual basis. 

“This enables them to preserve cash reserves over time and maintain (and grow) dividend payments to shareholders even where there are dividend cuts in the underlying portfolio holdings.”

Annabel Brodie-Smith, communications director at the AIC, agrees investment trusts have the ability to smooth dividends.

“This means that investment companies can hold back up to 15 per cent of the income generated in good times to pay it out when times are tough.”

She notes, in comparison, open-ended funds have to pay out all their income each year.

Investing far and wide

Another reason investment companies are suited to providing income is the access they have to a wide range of investments, points out Ms Brodie-Smith.

“Whereas many open-ended funds are restricted to investing in certain types of shares and securities, investment companies don’t have this restriction,” she explains. 

“In addition, asset classes such as property and infrastructure can offer a higher level of income, and being illiquid, are better suited to the closed-ended structure of an investment company.”

Investment trusts have a third feature which allows them to pay out a steady income stream, although this is more of a last resort.

Ms Brodie-Smith says: “Lastly, investment companies have the ability to pay income out of capital profits. While used quite sparingly, this can be useful and helps meet shareholder demand for income in a low interest rate environment and potentially can lead to investment companies being re-rated to trade on lower discounts – another benefit for shareholders. 

“Clearly investment company boards have an important role to play overseeing any change in the dividend policy and ensuring it is in shareholders’ best interests.” 

She reiterates shareholders have to approve the change in policy to allow the investment company to pay income out of capital profits.