City of London IT: small caps income an option ahead

But despite this there will be a slow return to growth thereafter.

Job Curtis, fund manager of City of London Investment Trust, believes most UK dividend cuts have been made, though some companies could still cut them and dividend growth will be restrained in the next year or two.

He said: "Markets are anticipating recovery but dividends lag the recovery."

The FTSE All Share historic price earnings ratio is 17.7x compared to 7.41x at its low on 6 March this year.

The trust is going to continue to its traditional focus on large caps for the time being, in particular multi-nationals, but could look to smaller caps further ahead. Currently it has an allocation of around 20 per cent to mid caps with a few smaller caps.

Curtis notes the recent bounce among smaller caps and said he has an open mind on this end of the market, and exposure to these could increase.

This would also mean the trust increasing its number of holdings as it becomes more confident on small and mid-caps. Currently it has around 89 stocks, down from 102 companies in 2008, as it focuses on companies with attractive dividend yields and growth.

However, the fund would not hold fewer than 75 stocks.

Curtis said an example of a highly cash generative small cap is Smiths News, of which City of London IT holds about 2.5 per cent of the shares. This has performed well over one year, with the newspaper distributor benefiting from good volumes and increasing market share.

But it is not a high growth stock.

Meanwhile, Gervais Williams, fund manager of the Gartmore Growth Opportunities Trust anticipates a future improvement in income from AIM stocks.

However, Curtis said currently there are difficulties for companies paying dividends across the UK market, with around 53 per cent of FTSE 350 companies having cut their dividends. He notes that 52.8 per cent of all UK dividends come from seven large cap stocks (BP, Shell, Vodafone, HSBC, GlaxoSmithkline BHP Billiton and AstraZeneca.)

City of London IT is focused on global stocks with exposure to area such as Asia, while smaller caps are domestically focused. This is due to concerns over UK consumer spending, while Curtis also believes international companies listed in the UK are good value.

He also favours exporters as Sterling is currently weak.

Multi-nationals in the fund’s top ten holdings include its largest holding BP accounting for 6.6 per cent of the fund, as of 31 August.

It also has British American Tobacco, Royal Dutch Shell, HSBC, Glaxosmithkline and Diageo.

Curtis expects BP and Royal Dutch Shell to maintain their dividends, with the likelihood that British American Tobacco and Diageo will grow theirs based on resilient demand for their products in global markets.

Over the medium-term Vodafone could improve its dividend as it starts to receive these from its 45 per cent stake in US based Verizon Wireless, though in the short-term Vodafone's increase is likely to be low single digit growth.

But Curtis does not feel that the trust need to raise its allocation to Europe – currently 4.3 per cent – though it could raise this to 15 per cent. Domestic facing stocks with good dividend prospects include defensives Scottish & Southern Energy and National Grid.

He added: "Barclays said it will restart paying dividends albeit from a low level, while HSBC’s seems secure from its reduced level, and growth could return next year. However the trust reduced its bank holdings over the year to 30 June, including to Barclays.