How Investment Trusts Use Reserves to Boost Income Payments

Investment companies have a clear advantage over their open ended brethren when it comes to providing a consistent and rising level of income to investors

David Holder 8 October, 2015 | 9:21AM
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This article is part of Morningstar’s Guide to Income Investing. Whether you are looking grow your pension pot, or invest for retirement income, this week we have all the news, information and education you need.

With interest rates in the UK at record lows of 0.5% since March 2009 many investors, typically those in retirement, understandably continue to be focused on income generating assets from within their investment portfolios to meet their ongoing income requirements.  

Unlike a company which may choose to make an acquisition with spare cash, closed-end funds reward investors

Investment companies have a clear advantage over their open ended brethren such as unit trusts when it comes to providing a consistent and rising level of income to investors. The concept of the revenue reserve is central when it comes to maintaining a regular and consistent flow of dividend payments for investors.

In essence the investment company can retain part of the dividend income received from the underlying investments each year and deposit this on the revenue reserve. This reserve can provide a buffer when an underlying holding unexpectedly cuts its dividend or it may allow the fund manager slightly more flexibility when it comes to positioning the portfolio. For example the current sustained low commodity price environment may constrain the future ability of companies operating in these areas to pay a dividend in the medium term.

Revenue Reserves Allows for Flexible Investment

The revenue reserve could play an important role in moderating these potential shortfalls. Alternatively the existence of a revenue reserve could allow a fund manager some flexibility to invest in currently lower yielding securities safe in the knowledge that the revenue reserve can make up a temporary shortfall in income whilst he waits for the dividends to come to fruition over the medium term.        

Unlike a conventional company which may choose to retain earned income for future expenditure or an acquisition, the investment company revenue reserve will be paid to investors at some point in the future. Used prudently this reserve can smooth the distribution of income for investors. This in concert with the increasing utilised quarterly income distribution provides much needed assurity for those investors reliant on their regular investment income.

Closed-end Funds Increase Dividends for Decades

According to research recently published by the Association of Investment Companies and from information drawn from own data there are 18 investment companies who have over 20 years of providing annual dividend increases and 18 also who have a similar record of between 10-19 years. Within these figures there are a remarkable 10 Investment companies have maintained a record of increasing their dividends for over 40 consecutive years.

This record of long term rising dividend payments speaks to the longevity, prudence, and consistency of approach inherent within many investment companies. We believe that Investment Companies provide a key solution for investors who value the sustainability and consistency of the income that they derive from their investments.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

David Holder  is a senior investment research analyst at Morningstar