The average IA UK Equity Income fund has paid out considerably more in dividends than its average closed-ended rival in the IT UK Equity Income sector over the past five years, according to the latest FE Trustnet study. 
The debate whether open- or closed-ended funds offer the better option for investors has rumbled on for some time now, with proponents of investment trusts pointing out that they tend to deliver a higher return over time due to their structure, while others argue OEICs and unit trusts offer lower risk exposure to markets.
One of the major draws of using investment trusts (apart from their historic outperformance relative to open-ended funds), though, is their ability to deliver a smoother income stream. This is because while managers of funds have to pay out all the income they receive each year, trusts have the ability to withhold 15 per cent of their revenue so that they can continue to increase their dividends in more difficult market conditions.
Nevertheless, data from FE Analytics shows this has meant IT UK Equity Income trusts have paid out less in dividends than open-ended funds over the medium term.
Annul and cumulative distributions since 2011
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Source: FE Analytics *figures based on a £10,000 investment in January 2011
According to FE Analytics, the average fund in the IA UK Equity Income sector paid out £2,502.24 in dividends on a £10,000 initial investment between 2011 and 2015. The average UK Equity Income trust, however, paid out £2,384.84 on £10,000 over that time period.
Also, while the large majority of trusts in the IT UK Equity Income sector have maintained an unbroken dividend track record over five years, just 20 per cent of equivalent open-ended funds have achieved that feat. However, taken together, the ‘average’ fund in the IA UK Equity Income sector increased its distribution in 2012, 2013, 2014 and 2015.
Of course, the IA UK Equity Income sector is home to a number of portfolios that extensively use covered call options at the expense of potential capital gains, which are absent within the closed-ended peer group.
Nevertheless, after removing those five ‘booster’ funds from the study, the average fund in the IA UK Equity Income sector delivered more than its equivalent trust rival over the five years between 2011 and 2015.
However, Ben Conway, fund manager at Hawksmoor, says this difference in income pay-outs between open and closed-ended funds will be due to the latter’s ability to withhold a portion of its annual income.
He notes that while open-ended funds may have paid out more in total dividends than trusts over time, investors can often find a smoother and more predictable income stream in closed-ended portfolios thanks to their revenue reserves.
It must also be noted that while the average IT UK Equity Income trust has historically yielded less than its average peer in the open-ended sector, it has delivered a far greater total return over the period in question.
Although both peer groups beat the FTSE All Share between 2011 and 2015, FE data shows that the IT UK Equity Income sector outperformed the IA UK Equity Income sector by more than 10 percentage points.
Performance of sectors versus index over 5yrs
Source: FE Analytics
This may not be overly surprising given the period in question has had a number of rising markets during which, thanks to aspects such as discount volatility and gearing, trusts tend to outperform funds. However, they have also delivered investors a smoother return.
For example, the average UK Equity Income trust has had a lower maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible moments – a lower annualised volatility and better risk adjusted returns (as measured by the Sharpe ratio) than the equivalent open-ended fund between 2011 and 2015, despite the fact trusts are often perceived to be more risky vehicles.
Turning back to dividends now, and while the average UK Equity Income trust has paid out less than its open-ended rival, when you combine the two peer groups together, investment trusts feature high on the list of the top income payers.
According to FE Analytics, out of the 91 portfolios with a long enough track record, two of the top 10 income-paying portfolios between 2011 and 2015 were investment trusts. Also, once the five booster funds are removed from the study, that number increases to four.
Top 10 income paying funds and trusts between 2011 and 2015
Source: FE Analytics * figures based on a £10,000 investment in January 2011
The highest income-paying IA UK Equity Income funds over that period include PFS Chelverton UK Equity Income, JOHCM UK Equity Income, Threadneedle UK Equity Alpha Income and Vanguard FTSE UK Equity Income Index – the only passive fund in this study.
None of those, however, has managed to pay out more than the British & American IT, with its distribution of £5,205.48 on an initial £10,000 investment.
The little-known fund of funds, which is one of the smallest in the sector and has a very sticky shareholder base, has also increased its dividend in each of those years.
While the trust has outperformed its sector and the FTSE All Share over the period in question with a total return of 107.3 per cent, the illiquid nature of its shares means the trust has delivered large and sharp drawdowns over that time.
Its historically large income pay-outs and extra-high current yield of 9.4 per cent are likely a result of its significant gearing, which currently stands at 106 per cent, according to data from the AIC.
The second highest income-paying trust is also another of the sector’s smallest members – Ed Beal’s Shires Income trust. It currently yields 6.1 per cent, is again highly geared at 25 per cent and paid out £3,129.87 on £10,000 over the period in question.
Shires Income is followed by Merchants Trust, which paid out £2,839.81 on £10,000.
The trust has been managed by Simon Gergel since April 2006 and though it is not the raciest member of the sector given it is benchmarked against the FTSE 100 and primarily invests in mega-caps, it has delivered a growing dividend in each of the last 33 years.
According to FE Analytics, Gergel has delivered dividend growth of 13 per cent since he has been at the helm and investors who bought £10,000 worth of the trust in January 2007 would have since earned £3,990.29 in income.
Merchant Trust’s dividend history in pence per share
Source: FE Analytics
The trust, which has narrowly outperformed its sector and benchmark over the past 10 years, currently yields 5.87 per cent due to Gergel’s big bets on stocks such as GlaxoSmithKline, Royal Dutch Shell and BP.
