The disaster back in 2010 highlighted the value of trusts’ ability to retain income in reserve and pay it out when their holdings halted dividends, and has contributed to the sector trading on a premium to the wider investment trust universe. Winterflood’s analyst team, headed up by Simon Elliott (pictured) believes their impressive dividend record will continue, providing further support to their share prices.
"The Income Growth sector has traded at a premium to the wider investment trust universe over the last five years," the analyst said.
"In addition, the sector was re-rated in April 2010 following the suspension of BP’s dividend after the Deepwater Horizon disaster in the US."
"The ability of investment trusts to use revenue reserves to maintain or even continue to grow their dividends despite being uncovered by earnings was recognised by investors as a key advantage."
"Although a small number of Income Growth funds were forced to cut their dividends, the majority did not and this greater dividend certainty led to premium ratings."
The average trust in the IT UK Growth & Income sector has done much better than the FTSE All Share over the past few years, according to data from FE Analytics.
The Winterflood analyst suggests this is not just due to investor appetite for the underlying stocks but also for the ability of trusts to smooth dividends.
Performance of sector against index over 3yrs
Source: FE Analytics
This ability could be particularly useful to investors if warnings carried by FE Trustnet today from Standard Life’s Thomas Moore turn out to be valid.
Moore says that many of the sectors favoured by equity income managers are starting to look quite expensive and could be due a de-rating if earnings growth doesn’t materialise – as looks likely.
Investors who focus on headline yield rather than companies with the earnings to provide a growing payout could suffer, the manager warns.
Moreover, FE Trustnet reported last week that dividend cover has generally reduced in UK companies, making the increasing sustainability of income coming from investment trusts all the more attractive.
Winterflood analysts say the ability to maintain and grow a yield is one of the key advantages of the closed-ended structure.
"One of the most attractive aspects of the UK Income Growth sector is the ability of the funds to grow their dividends over the longer term," they said. "The majority have been able to achieve this, outstripping inflation over a 10-year period."
"Finsbury Growth & Income has achieved the strongest dividend growth despite actually cutting its dividend in 2010 following the banking crisis."
"Troy Income & Growth has recorded negative dividend growth, although this was the result of the fund’s reconstruction in 2009 when its management contract moved to Troy Asset Management and its structured debt was repaid."
Some investors worry about the valuation of dividend-paying companies at the current point after many years of them being in favour with income investors and defensive investors – and even in some cases from growth investors looking for access to the emerging markets story through consumer staples or basic industries. Moore says valuations have certainly become toppy in some areas.
The Winterflood analysts say they think the sector is adaptable enough to prosper.
"Clearly there will be market volatility from the asset class, but over the long-term we believe that these funds are well placed to grow their dividends and provide capital growth," they said.
"In addition, many of these funds benefit from low management fees."
Data from the AIC shows that 13 trusts in the sector have ongoing charges equal to or lower than 1 per cent, with City of London (0.44 per cent) and Temple Bar (0.51 per cent) at the lower end of the scale.
"We believe that this increases their attractiveness compared with equivalent open-ended funds, particularly when the greater dividend certainty that the structure provides is considered."
"Consequently, we believe that the sector’s premium rating is sustainable as long as the low interest rate environment persists and assuming that a significant fall in markets is avoided."
Winterflood favours two trusts in particular: Perpetual Income & Growth and Diverse Income Trust.
The £816m Perpetual Income & Growth trust is managed by Mark Barnett for Invesco. It holds a mixture of UK large and mid caps along with some overseas stocks such as Novartis, Roche and Reynolds American.
The trust has made 67.28 per cent over three years as the FTSE All Share has made just 28.86 per cent. The trust’s NAV has risen by 60.1 per cent.
Performance of trust vs sector and benchmark over 3yrs
Source: FE Analytics
"The fund, which has a yield of 3.2 per cent, has achieved annualised dividend growth over the last 10 years of 8.4 per cent, which is one of the strongest levels in the UK Income Growth sector," said the Winterflood analysts.
"It also has revenue reserves equivalent to 1.1 years of dividends."
"The fund has a strong long-term performance record, with the NAV up 233 per cent over the last 10 years, compared with a 134 per cent rise in the FTSE All Share."
"Its strong performance record is reflected in the fact that it now trades at a 1.7 per cent premium to NAV."
"The fund has also outperformed Edinburgh IT in NAV terms since the appointment of Invesco Perpetual’s head of investment, Neil Woodford, as manager in September 2008."
"The two funds have similar investment approaches and themes; however, Edinburgh IT is more defensively positioned, with a lower weighting to mid and small cap companies."
The £230m Diverse Income Trust has much less of a track record, having been launched in 2011. However, the analysts say it is a good diversifier from a traditional income and growth trust.
"Diverse Income Trust is a multi-cap income investment trust that aims to deliver lower volatility than most comparative funds and the FTSE All Share," they said.
"The fund has performed strongly since its launch in April 2011 and, given its small cap bias, we believe that it is complementary to most other UK Income Growth funds, which tend to have a significant exposure to mega-cap stocks."
Performance of trust vs sector and index since Apr 2011
Source: FE Analytics
"The fund also has a robust discount control mechanism in the form of an annual redemption facility that allows investors a full exit at NAV."
"The shares currently trade on a small premium to NAV and offer a 2.9 per cent yield. We believe the fund is attractive on a total return basis."
The trust has ongoing charges of 1.84 per cent. Charges on Mark Barnett’s fund are 0.94 per cent before the performance fee and were 1.93 per cent in total last year.
