Weathering the storm: how UK equity income trusts have protected their dividends

Investment trusts have a key advantage over open-ended funds as they can retain part of their income so as to maintain a sustainable dividend, a safeguard that paid off handsomely during the pandemic.

A recent report by the investment companies’ team at Investec has looked at how the UK equity income sector held up during the lockdown when many businesses had to cut their distributions. Their findings highlight one of the key benefits of these closed-ended funds.

Investment trusts can retain up to 15% of their annual income and add it to their revenue reserves, which can then be used to support the distributions in difficult years. This safeguard has enabled 12 of the 16 vehicles in the sector to continue to deliver a progressive dividend throughout the pandemic, while another was able to maintain it.

It was a completely different story in the UK equity income open-ended funds sector, where according to Investec, the average dividend cut last year was 29%. These vehicles are required to distribute all of their revenue each year, which can make a huge difference to anyone who relies on the investment income.

Strong recovery in dividends

There has been a significant and speedy recovery since last year when UK dividends were cut by 43% to £64.3bn. According to data from Link Group, payments in the first three quarters of 2021 were £79.9bn, 50% higher than the corresponding period in 2020 and just 15% lower than the first three quarters of 2019.

Some investment trusts have weathered these sharp changes better than others. For example, Dunedin Income Growth (LON: DIG) and Murray Income (LON: MUT) suffered only modest falls in earnings per share (EPS), from which the dividends are paid, of 9.8% and 12.6% in the financial years ended 31 January 2021 and 30 June 2021 respectively.

At the other end of the scale, trusts like Edinburgh (LON: EDIN), Lowland (LON: LWI) and Temple Bar (LON: TMPL) experienced a complete collapse in EPS, with falls of 41.8%, 50.3% and 76.4% in the financial years ended 31 March 2021, 30 September 2020 and 31 December 2020. The good news though is that the recovery is already feeding through and the strong rebound in dividends should be reflected in the next sets of interim and final results.

The impact on the revenue reserves

Many investment trusts have had to draw heavily on their revenue reserves to maintain their dividends during the pandemic, but most still have a healthy level to protect their distributions in future years. According to Investec, those with more than a year’s worth of dividends set aside include: Dunedin (LON: DIG), Diverse (LON: DIVI), JPMorgan Claverhouse (LON: JCH), Finsbury (LON: FGT) and Law Debenture (LON: LWDB).

The trusts more at risk with less than six months’ of dividends available according to the latest accounts are: City of London (LON: CTY), Lowland (LON: LWI), Temple Bar (LON: TMPL) and Invesco Select – UK Equity (LON: IVPU). City is by far and away the largest of these and has the highest yield at around five percent, it has also managed to increase its annual dividend for more than fifty consecutive years, which is a record that it is keen to maintain.

It is clear from this analysis that if you depend on your investment income for your day to day expenses then a prudently managed investment trust would be the most reliable option. You need to stick to those that you feel comfortable with that pay sufficient yields and have adequate levels of revenue reserves in case we hit another downturn.