If income is the target
The squeeze on income-yielding assets has made the hunt difficult for income investors. Interest received on savings accounts is close to zero, translating into a negative real return when inflation is accounted for.
Bonds – a traditional asset class for income – also yield poorly (German 10-year bonds were actually negative until quite recently). This is because for years central banks from across the globe have been printing money to buy bonds and drive down interest rates, hoping to encourage spending to rattle domestic economies into growth. It has skewed the risk / reward dynamic, prompting investors to consider dividend-paying stock market investments to find a better return.
The environment has led to rampant demand for income yielding equities, pressure that is only likely to increase – the pension freedoms that came into effect in April 2015 have enabled retirees to sidestep annuity purchases and instead draw income direct from their invested pensions. Coupled with rates now at half of what they were in 1994, annuity sales have fallen dramatically, with two thirds of retirees electing for non-annuity options, including equity income.
There are numerous equity income products on the market, but we think investing for equity income within the investment trust structure may be the best way for investors to achieve a long-term income objective.
A smooth payment
The investment trust sector is a small corner of the industry – around 400 investment trusts exist today. They differ from open-ended funds (known as OEICs and Unit Trusts in the UK) in a number of important ways: the pool of money they invest is fixed allowing for much longer investment horizons; they can borrow money (gearing) from institutions such as banks to make extra investments with aim of boosting returns (this can be double-edged sword however as it will also exaggerate loses); they have an independent Board tasked specifically with looking after shareholder interests.
In particular, one key difference aids the income investor: a UK-domiciled investment trust is permitted to retain up to 15% of its annual dividend income in a revenue reserve account. It means that during the more plentiful years a small percentage of the dividend payments can be put aside, so that during lacklustre years, for example during an economic downturn, the fund manager is able to use the reserve to top-up the dividend it pays-out to investors and smooth the income-stream over time. Open-ended funds, by contrast, must pay out all of their income which may lead to volatile payments.
This structure has enabled some stellar income records. According to the Association of Investment Companies (AIC) – the investment trust industry trade body – 19 investment trusts have been consecutively growing their dividends for 20 years or more. The City of London Investment Trust tops the list, having grown its dividend every year since 1966.
Upon reaching its 50-year milestone, the Trust’s Chairman, Philip Remnant, said: ‘I am delighted that City of London has reached this momentous milestone which demonstrates the strength of our long-standing conservative investment approach’.
Job Curtis has been the steward of this Trust since 1991, and he and the Board believe the smooth dividend payment to investors is a vital part of the Trust’s philosophy.
A good investment for the long term?
Investing over the longer term helps to mitigate some of the short-term risks and volatility inherent in equity markets, and can maximise your potential returns. The City of London Investment Trust aims to unlock value in equities on a medium to long-term basis, potentially interesting investors looking to gain UK stock market exposure through a broad, conservatively managed portfolio of blue-chip investments.
Looking back over the past 50 years – the length of City’s unbroken dividend record – short term investors may have been unnerved by any number of macroeconomic events: the 73/74 bear market, the winter of discontent, severe unemployment, interest rates hikes to 15%, ‘Black Monday’, ‘Black Wednesday’, The Asian Financial Crisis, the dotcom crash, or the Global Financial Crisis; all potentially encouraging performance damaging withdrawals in the process.
The chart below demonstrates the performance of £100 invested 50 years ago in various assets, including The City of London, and run through to the present day.
Source: Henderson Global Investors, Barclays; as of December 2015. Top to bottom: Barclays Equity Index Total Return; Gilt Total Return (UK government bonds); the Retail Prices Index (a measure of inflation); and City of London Total Return. The City of London’s benchmark is the AIC UK Equity Income sector.
City of London
Adjusted for inflation, £100 in cash would be worth just over £1600 today; with income reinvested, £100 put into gilts would have handed back just under £7,000; a broad basket of UK equities would have earned you over £27,000; and £100 into the City of London would have earned just under £64,000. Whatever your investment, you would have achieved the best outcome with a long term approach. Please remember though that past performance doesn’t indicate what will happen in the future. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
Charges have become an important issue for investors, particularly as many active funds across the globe have failed to outperform their benchmarks. This has led to a rise in popularity of passive strategies such as ETFs, which attracted a total of $200bn in inflows in 2015 versus $124bn of outflows for active funds over the same period.
The reason is that while, in a single year, one fund’s higher charge may not dramatically effect performance in comparison to a lower charging fund, the compounded effect over many years can be a significant drag. Using a simple mathematical model, a £10,000 investment growing at 6% for 30 years would be worth around £51,000 in a fund charging 0.4%, but only £42,500 in an identical fund charging 1%.
The City of London’s Board have been determined to keep its ongoing charges low for investors, which they are able to do because of the Trust’s size (current total assets are over £1.4bn) and its ability to spread the Trust’s running costs over a large base of investors. This means it charges the lowest in its sector, at 0.42% per annum (at Trust year-end 30/06/2016).
So why consider City of London?
- Considering current low yields and savings rates, income-yielding equities are an attractive asset class.
- The Trust has weathered a myriad of economic events and market turmoil through its conservative, blue-chip investments, and presents a potentially good investment for the long term.
- It has the longest growing dividend record of any investment trust, aiming to provide a smooth stream of income to its investors.
- It has the lowest ongoing charge of any investment trust in its sector, reducing the drag to potential future performance.
Where the Trust invests in assets which are denominated in currencies other than the base currency then currency exchange rate movements may cause the value of investments to fall as well as rise.
The Trust may use gearing as part of its investment strategy. If the Trust utilises its ability gear, the profits and losses incurred by the trust can be greater than those of a trust that does not use gearing.
If a fund is a specialist country-specific or geographic regional fund, the investment carries greater risk than a more internationally diversified portfolio.
Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser.