A whole raft of UK companies have announced dividend cuts in the last few weeks and this will have a knock on effect on the income paid out by the funds that invest in them.
The analysts at Numis have looked at the impact of the reductions and suspensions announced up to April 2 on the investment trusts that operate in the UK equity income sector. Their calculations are based on the most recent full portfolio data that is typically end of December, January or February, but they do not reflect any changes made by the managers since then.
It is thought that the worst affected is Temple Bar (LON:TMPL), a value-oriented fund with large stakes in some of the banks that have been forced to suspend their dividends. According to Numis, just over 40% of its portfolio has experienced cuts or deferrals of dividends up to April 2.
Next on the list is the Merchants Trust (LON:MRCH), which invests in higher yielding UK companies, and Lowland (LON:LWI). Both have both seen around 30% of their portfolios affected by cuts or suspensions.
Trusts that invest in quality companies with strong balance sheets and market positions have been largely unaffected, although this could change if the lockdown goes on for longer than expected. The main examples are Finsbury Growth & Income (LON:FGT), Troy Income & Growth (LON:TIGT) and Dunedin Income Growth (LON:DIG), which have all seen less than 10% of their portfolios experience cuts.
The good thing about investment trusts is that they may be able to make up some or all of the shortfall by using their revenue reserves. Many of these vehicles have accumulated substantial sums that they can call on, while others can also draw on their capital reserves to support their dividends in the face of falling income.
Of those most affected by the cuts, Merchants has revenue reserves equivalent to around 50% of last year’s dividends, while Lowland has cover of just over 60% and Temple Bar about 70%. At the other end of the scale, Dunedin Income Growth and Finsbury Growth & Income are both in the 80% to 90% range and look pretty safe at this stage.
Being able to draw on their revenue reserves is a massive advantage over their open-ended counterparts and gives them a much better chance of being able to deliver a steadily increasing stream of dividends.
The best example of this is the City of London Investment Trust (LON:CTY), which has built up a record of 53 consecutive years of income growth. Just over a fifth of its holdings have announced cuts, but it has recently been able to declare a third interim dividend and reaffirmed its commitment to paying a fourth after the 30 June year end.
At June 2019, City’s revenue reserves were £58.3m. According to Numis, after adjusting for the payment of the final interim dividend, this figure would go down to £40.4m, which is equivalent to 0.6 years’ of dividends.
If the lockdown is relatively short and companies can get back up and running without too much delay, then investment trusts with a decent level of revenue reserves may well be able to make up the shortfall in their income. Unfortunately if the impact is longer and deeper then the boards may have to accept the inevitable and lower their dividends to a more sustainable level.