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Plough the yield

In times of market trouble, many investors fall back on the tradition of dividends, although such funds are not looking particularly strong at the moment from a capital perspective.

Funds distributing income have suffered alongside other equity portfolios but it is worth remembering that is on the capital side only.

These funds still feature the advantage of an income distribution, the consistency of which is becoming particularly attractive and which may not be as rare a find as many think.

Job Curtis, who runs the City of London investment trust, says a consistent level of income is important for many investors in difficult market conditions.

He says: “Receiving an income stream is a comfort, although not as much when capital is being lost. It is reassuring if you can provide a rising income stream as it helps investors to live with volatility more easily.”

Many closed-ended funds in the UK may be better equipped to continue meeting investors’ income needs, having a long track record in making consistent payouts.

Witan announced recently that it will pay an interim dividend of 4.3p per ordinary share on September 5. This payment for the year ending December 31, represents an increase of 4.9 per cent on the 4.1p per share paid as a first interim dividend in 2007.

Witan is not alone in such a trend, despite all the bad news that investors have been swamped with over recent months. According to one recent newspaper report, there are 31 trusts that can claim a record of providing a rising dividend for the past 10 years.

The Henderson-managed City of London trust is said to hold the record for one of the longest runs, having just hit 42 years of providing a rising dividend. The rise has been on the low side in some years but in the past three years the increases have averaged 10 per cent.

Investment trusts have the capability to hold back payouts in good years to sustain the trust through poor periods. Unlike open-ended vehicles, investment trusts can hold back up to 15 per cent of distributions in a revenue reserve which enables them to continue to pay out when times look tough. The tough times seem to be upon us.

Curtis says the past year has been good for dividends and the trust now has a revenue reserve equal to almost one year’s dividend. Since the trust does not report until September, Curtis cannot say if there is an intention to dip into that reserve any time soon but he does note that recent years have been good for dividend growth. The difficulty lies ahead.

Having worked on City of London since 1991, Curtis says he has seen this type of environment before and it is a time for managers to be careful about selling on the basis of a company cutting its dividend. Companies such as Barclays and BP made cuts in 1991 but he says that presented a buying opportunity. He says: “A dividend cut can mark a turning point on a capital appreciation basis.”

Annabel Brodie-Smith, of the Association of Investment Companies, says trusts with income streams look very attractive at the moment, considering the discount levels at which they are trading. Trusts in the UK growth & income and global growth sectors are yielding an average of 4.4 per cent although there are some as high as 9 per cent, she says.

The open-ended side is not without opportunity in this area. M&G last week launched a global dividend fund that aims to exploit consistent dividend payouts. Rather than selecting stocks on a pure capital appreciation or yield consideration, the manager seeks to find opportunities in companies where there is a solid plan for distributing back to shareholders. The fund, which has a starting yield of 4 per cent, aims to mirror the companies in which it invests by providing a steady and rising level of dividends over time.

With an initial weighting to the UK of just over 5 per cent, the fund differs from the equity income vehicles that dominate in the UK retail space but falls into the overall trend of managers looking to exploit dividend growth elsewhere.

Yields may be lower on average in the US but M&G global dividend manager Stuart Rhodes says there are a number of companies with a long, sustained track record in dividend payments. The US is quite polarised between those companies that pay out quite consistently and those which do not provide any dividends.

Rhodes says: “There are hundreds of companies in the US which have consecutively increased their dividend every year for the past 30 years. I could probably count on one hand the number of companies that have done that in the UK.”

One of the bigger positions in his fund, Johnson & Johnson, is one such example from the US market. Rhodes says: “The company has allocated capital with immense discipline, increasing returns year after year, expanding profitably and growing the dividend for 44 consecutive years. With limited scope for competitive pressure, return on capital is likely to remain high, resulting in significant value creation for shareholders.”

Despite the bleak market outlook for global equities overall, both managers are still confident of opportunities for their respective portfolios. Curtis says he sees value in areas such as tobacco, utilities and telecoms as well as continued support in the big oil firms. He also feels that the sell-off among the financials has been indiscriminate and can still provide opportunity.

Rhodes, whose fund seeks to be sector-neutral, has around 18.5 per cent of his fund invested in financials. One such holding is US Bancorp, which yields 6.1 per cent and has provided 35 years of consecutive dividend increases.

Rhodes says the financial services company has a strong franchise across the US and a disciplined approach to capital allocation. He says: “Unlike many of its peers, it has maintained a long-term value creating strategy and avoided the wasteful spending that has taken place across the banking industry in recent years.”

Rhodes, like Curtis, is wary in the current market of chasing companies featuring high yields. There can be a fine distinction between companies assessed as undervalued and those that are distressed and offering compensatory yields.

Rhodes says a distressed company can be identified as having to react to bad times at the potential risk to the long term and he is steering clear of the area. Curtis also says he is avoiding high-yield value traps.

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