Positive outlook for dividends, says AIC

The continued appetite for income amongst investors in the low interest rate environment has contributed to a significant narrowing of discounts in the investment company income sectors.

For example, the UK Growth & Income sector’s average discount is currently at 1.2 per cent, compared with 7.1 per cent this time last year.

Investment companies have a strong dividend record as they do not have to distribute all their dividends each year, and in good market conditions can transfer up to 15 per cent of income annually to the revenue reserve.

The ability to retain income when markets are strong has been a key advantage of investment companies throughout the economic crisis and has enabled many to maintain an unbroken record of dividend increases – 44 years in the case of City of London Investment Trust.

The top-four of the highest-yielding equity income investment companies boast dividends of between 5.5 per cent and 6.3 per cent and there are a further 12 that deliver a dividend yield of four per cent or higher.

This is all the more impressive against the backdrop of the FTSE, which is currently yielding 2.9 per cent. Not surprisingly, many of these companies are trading at a premium or close to par, but many have discounts wider than the investment company sector average.

For those investors who don’t need to draw an income from their investments, reinvesting dividends can bolster their capital significantly. Over 10 years, £1,000 invested in the average investment company will return £1,146, but with dividends reinvested this rises to £1,818; an increase of 24 per cent.

The difference is even more pronounced over 20 years, as an investment of £1,000 with dividends reinvested would produce a total return of £6,757, which is 58 per cent more than if an income had been drawn.

The fourth-quarter GDP estimate and inflation figures have raised concerns about the UK economy but have been given short shrift by managers and investment advisers, who generally remain positive on the outlook for UK equities.

James Henderson, manager of Lowland Investment Company, a UK Growth & Income investment company, said: "UK equities will in aggregate produce over 10 per cent dividend growth in 2011."

"Given the current yields, this makes a compelling story for shares. Inflation may pick up short-term but in the developed world wage increases are running at low levels and are unlikely to increase. This will mean inflation in the medium-term is subdued."

Tim Cockerill, head of research at Ashcourt Rowan, said: "The fourth-quarter GDP figure was a surprise to everyone, which normally would have sent shivers through the stock market, but it hasn't."

"Strangely, it seems to have almost been disregarded by the market. Investors should remain firmly focused on the long term. Markets don’t go up in straight lines as we know all too well and economies do not run smoothly."

"So it is important to have a balanced portfolio, spread geographically as well as by asset classes and market cap."

Let’s hope the managers and advisers are correct about the UK. While it is impossible to predict what will happen in markets, it is clear that investment companies’ ability to sustain dividend increases is a strength that is an important contributor to investment returns.