Laura Suter: Why investment trusts are dividend heroes

Laura Suter looks at the suitability of investment trusts for retirement income and asks if there is a platform problem blocking adviser's use...

I’m a big fan of investment trusts, and use them in my own investment portfolio (although that seems a grand name for the sums involved) alongside funds and passives.

I know that with gearing and the potential to trade at a persistent discount, there are additional factors to consider when compared to picking a fund, but I understand those and am okay with that.

But many advisers appear to disagree, and simply aren’t using investment trusts for their clients. Recent research from consultancy the langcat found that advisers still prefer to recommend funds rather than investment trusts.

Its research found that despite the Retail Distribution Review being hailed as a catalyst for a surge in the use of investment trusts, when commission was banned on open-ended funds, this hasn’t actually panned out. In fact, 95% of assets on advised platforms are in funds or cash – showing the lack of use of investment companies.

But why? Half of advisers said that trusts are not as easy to use as funds, while almost 40% said that they didn’t work from a client suitability point of view. This backs up findings from Cicero Research earlier this year, which found that 57% of advisers don’t use trusts as they are not confident in their knowledge.

Popularity surge

That is changing though, with the langcat figures showing a 46% increase in adviser purchases of investment trusts in the past year, rising to almost £1bn for 2017.

This is with good reason. There are a group of reliable dividend-paying trusts that have earned the moniker of “dividend heroes”. These are trusts that have increased their payouts to investors every year for the past 20 years. In some cases, the number of years is far higher.

These reliable payers are ideal for those in retirement, who want their investment income to help supplement their other retirement income.

I did some further digging of the investment trust dividend heroes, including those tipped to be “next generation” dividend heroes, namely those with 10 years or more of consecutive payout increases. There are 42 in total.

I found a sterling combination of income payouts and capital growth – every investor’s Holy Grail.

For example, take British & American investment trust. It was launched in 1996, and has raised its dividend every year for the past 22 years. The trust’s share price has actually fallen in the past 10 years, if you ignore any income paid out.

However, if you had reinvested that income back into the trust you’d be sitting on a 139% increase over the past 10 years. Put simply, if you’d invested £10,000 in the trust 10 years ago you’d be sitting on almost £24,000 today. What’s more, that same £10,000 invested 10 years ago would be netting you £1,037 in annual income today.

That’s not the only one. Schroder Oriental Income, which has been run by Matthew Dobbs since its launch in 2005 and has raised its dividend every year since, would have turned £10,000 into £39,000 over the past 10 years if you’d reinvested dividends. Today that £10,000 invested 10 years ago would be generating a growing annual income of £900.

The list goes one, the ever-popular Scottish Mortgage trust, run by Baillie Gifford, has raised its dividend for the past 35 years and returned 438% over the 10 years on a total return basis, while Henderson Smaller Companies has delivered one of the highest total returns over the past 10 years, turning £10,000 into £51,700 and would be generating an annual income today of £790.

Going steady

Investment trusts are particularly suited to providing steady income for investors.

Their structure means that they can withhold up to 15% of the income they receive each year in order to be used in future years when dividends are thinner on the ground.

But there is one area of the langcat findings I haven’t tackled: namely that advisers found their platform either didn’t offer investment trusts or the costs prevented them from using trusts more.

These are valid areas that the industry needs to tackle. Large platforms that don’t currently offer trusts need to stop dragging their heels.

What’s more, the research found that adviser platforms that don’t discriminate as much on charges between products (of which AJ Bell is one, alongside Alliance Trust Savings, Ascentric and 7IM) see higher investment trust usage on platform.

This shows that tweaking pricing structures can have a big impact on adviser usage – and in turn a big impact on investors’ retirement portfolios.

Laura Suter is personal finance analyst at AJ Bell