Basic Question: Marcus vs. FTSE 100 Dividend

jamei305

Audaxer said:

I think this is where some long-established UK Equity Income Investment Trusts with decades-long records of increasing dividends are much better options than for example a FTSE100 tracker, as they have been able to keep increasing dividends in previous equity crashes. If these ITs are able to maintain their records in this crisis, the yields would be in excess of 5% if bought at the present time.
 

These ridiculous ever-increasing-dividend claims by certain ITs obviously need to stop at some point, otherwise the ITs concerned will start making increasingly questionable investment decisions as they desperately try to shore up their dividend each year to avoid breaking their 60-whatever year record.

bowlhead99

jamei305 said:

Audaxer said:

I think this is where some long-established UK Equity Income Investment Trusts with decades-long records of increasing dividends are much better options than for example a FTSE100 tracker, as they have been able to keep increasing dividends in previous equity crashes. If these ITs are able to maintain their records in this crisis, the yields would be in excess of 5% if bought at the present time.
 

These ridiculous ever-increasing-dividend claims by certain ITs obviously need to stop at some point, otherwise the ITs concerned will start making increasingly questionable investment decisions as they desperately try to shore up their dividend each year to avoid breaking their 60-whatever year record.

Yes, but that 'some point' could be another half century from now, as for a number of years investment trusts have been free to pay dividends out of not just current net income, but out of retained income reserves, and capital reserves, allowing easy smoothing of naturally lumpy long term increase in dividends.

While an OEIC can't increase its dividends if its underlying investment income per share net of costs doesn't increase over the prior year (because its dividend simply *is* a payout of its underlying investment income per share net of costs), an investment trust can use any unpaid net income from previous years and all those lovely compounded capital gains from its portfolio over the years. Since a law change in 2012, trusts have been free to get authority from shareholders to distribute realised capital profits as dividend, and many trusts have 

taken advantage of that rule.

One would expect that over time, dividends per share would increase simply due to inflation. An investment trust now should be getting much more income than it was fifty years ago unless it has been a spectacular failure.

CTY for example pays much more dividend now than it did five decades ago - that's not in itself surprising and should be the same for nearly any trust or fund. The fact that it has not just increased its dividend over 50 years but actually increased it in each of the years sounds initially impressive, but once you realise the 'smoothing' has just been achieved by holding back from potential payouts in the good years, it's not rocket science. As of the last annual report they have over £50m of revenue reserves (over half of it built up in the last decade) that can be used to 'top' up dividends in lean years. So there won't be a problem keeping that 'unblemished track record' this year even if half the portfolio doesn't pay them what they anticipated.

If they were an OEIC, the tax rules would have forced them to already pay that income reserve out - but they're not, so they haven't (they only have to pay out 85% of a given year's income unless they want to pay more) so it's available for smoothing the lean years.

So, inflation allows your dividends to rise over time and up to a 15% holdback in good years as permitted by regulations allows you to smooth that rise. And a trust that does successfully grow its size in excess of inflation will generally reduce its operating costs as a proportion of asset value, due to economies of scale, meaning the drag on gross income becomes less as a percentage as time goes on, so distributable income can go up faster than gross portfolio income.

So, assuming we don't get chronic deflation there isn't necessarily a barrier to an investment trust continuing to increase the absolute level of dividends over time - and with consistency, thanks to the permitted income hold-backs and top ups from releasing those hold-backs. For investment trusts that can pay out of capital, they have even more reserves that can be used for the smoothing process, because the typical capital gains they are banking over time will be a lot more than 15% of the income - so that even if they charge a lot of the management fees and finance costs to capital to preserve income, they end up with potentially hundreds of millions of pounds of capital reserves that could be used to fund a short term top-up of dividends if their constitutional documents allow.

As such, they would not need to be, "making increasingly questionable investment decisions as they desperately try to shore up their dividend each year to avoid breaking their 60-whatever year record".

Alistair31

Timely from Monevator; 

The reality behind investment trust revenue reserves

https://monevator.com/the-reality-behind-investment-trust-revenue-reserves/

steampowered

Zanderman said:

In your view perhaps! That was my point.  Your view is your view.  It can't be applied to everyone.

Anyone considering investing does these days have to fill out a questionnaire on whether they understand and accept the risks of investing.  The risks highlighted include the need for longer term commitment and also the risk of losing capital. Some people don't want to risk capital so will not proceed when reminded (quite rightly) of this risk. That's not irrational that's just very cautious.  

The problem with your analysis is that it ignores other types of risk to capital.

Over the long term, inflation risk presents a greater risk to capital than the investment risk associated with shares.

While I do understand why people might want to throw money away by keeping it in cash savings over a long term period for emotional reasons, it is irrational behaviour in economic terms.

Sailtheworld

steampowered said:

Zanderman said:

In your view perhaps! That was my point.  Your view is your view.  It can't be applied to everyone.

Anyone considering investing does these days have to fill out a questionnaire on whether they understand and accept the risks of investing.  The risks highlighted include the need for longer term commitment and also the risk of losing capital. Some people don't want to risk capital so will not proceed when reminded (quite rightly) of this risk. That's not irrational that's just very cautious.  

Over the long term, inflation risk presents a greater risk to capital than the investment risk associated with shares.

What you mean is that over the longer term shares are likely to outperform cash. That's because investors in shares expect / hope to be rewarded for the additional risk they're taking.

If there was an investment that offered the long term reward of shares with the risk of cash it would be best to stand clear of this board as wherecaniget0.1%extra, ratechaser and savetuppencehalfpenny stampede to get a bit of the action. I can see the threads now - 'I signed up 5 minutes ago and still haven't had confirmation - worried sick.' 'Can I get cashback for signing up'. 'Nationwide say it'll take more than 30 seconds to close my account - don't they know what loyalty means? Grrr!'

Audaxer

bowlhead99 said:

jamei305 said:

Audaxer said:

I think this is where some long-established UK Equity Income Investment Trusts with decades-long records of increasing dividends are much better options than for example a FTSE100 tracker, as they have been able to keep increasing dividends in previous equity crashes. If these ITs are able to maintain their records in this crisis, the yields would be in excess of 5% if bought at the present time.
 

These ridiculous ever-increasing-dividend claims by certain ITs obviously need to stop at some point, otherwise the ITs concerned will start making increasingly questionable investment decisions as they desperately try to shore up their dividend each year to avoid breaking their 60-whatever year record.

Yes, but that 'some point' could be another half century from now, as for a number of years investment trusts have been free to pay dividends out of not just current net income, but out of retained income reserves, and capital reserves, allowing easy smoothing of naturally lumpy long term increase in dividends.

While an OEIC can't increase its dividends if its underlying investment income per share net of costs doesn't increase over the prior year (because its dividend simply *is* a payout of its underlying investment income per share net of costs), an investment trust can use any unpaid net income from previous years and all those lovely compounded capital gains from its portfolio over the years. Since a law change in 2012, trusts have been free to get authority from shareholders to distribute realised capital profits as dividend, and many trusts have 

taken advantage of that rule.

One would expect that over time, dividends per share would increase simply due to inflation. An investment trust now should be getting much more income than it was fifty years ago unless it has been a spectacular failure.

CTY for example pays much more dividend now than it did five decades ago - that's not in itself surprising and should be the same for nearly any trust or fund. The fact that it has not just increased its dividend over 50 years but actually increased it in each of the years sounds initially impressive, but once you realise the 'smoothing' has just been achieved by holding back from potential payouts in the good years, it's not rocket science. As of the last annual report they have over £50m of revenue reserves (over half of it built up in the last decade) that can be used to 'top' up dividends in lean years. So there won't be a problem keeping that 'unblemished track record' this year even if half the portfolio doesn't pay them what they anticipated.

If they were an OEIC, the tax rules would have forced them to already pay that income reserve out - but they're not, so they haven't (they only have to pay out 85% of a given year's income unless they want to pay more) so it's available for smoothing the lean years.

So, inflation allows your dividends to rise over time and up to a 15% holdback in good years as permitted by regulations allows you to smooth that rise. And a trust that does successfully grow its size in excess of inflation will generally reduce its operating costs as a proportion of asset value, due to economies of scale, meaning the drag on gross income becomes less as a percentage as time goes on, so distributable income can go up faster than gross portfolio income.

So, assuming we don't get chronic deflation there isn't necessarily a barrier to an investment trust continuing to increase the absolute level of dividends over time - and with consistency, thanks to the permitted income hold-backs and top ups from releasing those hold-backs. For investment trusts that can pay out of capital, they have even more reserves that can be used for the smoothing process, because the typical capital gains they are banking over time will be a lot more than 15% of the income - so that even if they charge a lot of the management fees and finance costs to capital to preserve income, they end up with potentially hundreds of millions of pounds of capital reserves that could be used to fund a short term top-up of dividends if their constitutional documents allow.

As such, they would not need to be, "making increasingly questionable investment decisions as they desperately try to shore up their dividend each year to avoid breaking their 60-whatever year record".

Great response Bowlhead. That reinforces my view that for income seekers, these sort of Investment Trusts are a better buy than equity income funds at this time, because although the funds might have similar yields to the ITs, there is less certainty that the funds will be able to maintain the same level of dividends in these uncertain times.

bowlhead99

Audaxer said:
Great response Bowlhead. That reinforces my view that for income seekers, these sort of Investment Trusts are a better buy than equity income funds at this time, because although the funds might have similar yields to the ITs, there is less certainty that the funds will be able to maintain the same level of dividends in these uncertain times.

Yes, in a lean year they can simply sell out of some of their underlying investments to free up some cash to pay you the dividend, even if they don't receive much income for themselves.  So you would have a lower amount remaining invested than if they had paid you the natural income.

Of course, if you were in an OEIC you could just sell a few of your units of the OEIC to free up some cash to take a cash 'dividend' for yourself, with the same effect on the underlying portfolio (i.e. underlying investments held by the fund would be sold and you would have a lower amount remaining than if you had just taken the natural income). The difference is simply that the amount you encashed from the OEIC would be treated by the tax man as a capital disposal with capital gains treatment on the portion of it that's in excess of your cost for the units sold, instead of as a UK dividend with dividend tax treatment.

If you are literally an 'income seeker' for tax purposes because you have used all your capital gains allowances and haven't used any of your dividend allowance, you might have the preference for an investment trust that will pay you money that's classed as a UK dividend rather than making you do a small disposal and have a portion of it being chargeable to tax.  However many income seekers are not really seeking 'income', and may be doing their investment inside a tax wrapper anyway so are indifferent to tax character; they might self-identify as an 'income seeker' because more dividend sounds nicer than less dividend, but what they are really seeking is simply an ongoing periodic cashflow which meets their needs. As such, they are often indifferent to how they receive it (or would be, if they thought it through).

Audaxer

bowlhead99 said:

Audaxer said:
Great response Bowlhead. That reinforces my view that for income seekers, these sort of Investment Trusts are a better buy than equity income funds at this time, because although the funds might have similar yields to the ITs, there is less certainty that the funds will be able to maintain the same level of dividends in these uncertain times.

Yes, in a lean year they can simply sell out of some of their underlying investments to free up some cash to pay you the dividend, even if they don't receive much income for themselves.  So you would have a lower amount remaining invested than if they had paid you the natural income.

I thought in most cases the equity income ITs would still be able to continue to pay the dividends by dipping into their reserves built up to cover these times, so I didn't think the ITs like CTY would not need to sell any of their underlying investments to pay dividends?

coyrls

Audaxer said:

bowlhead99 said:

Audaxer said:
Great response Bowlhead. That reinforces my view that for income seekers, these sort of Investment Trusts are a better buy than equity income funds at this time, because although the funds might have similar yields to the ITs, there is less certainty that the funds will be able to maintain the same level of dividends in these uncertain times.

Yes, in a lean year they can simply sell out of some of their underlying investments to free up some cash to pay you the dividend, even if they don't receive much income for themselves.  So you would have a lower amount remaining invested than if they had paid you the natural income.

I thought in most cases the equity income ITs would still be able to continue to pay the dividends by dipping into their reserves built up to cover these times, so I didn't think the ITs like CTY would not need to sell any of their underlying investments to pay dividends?

The reserves are in the underlying investments.

Thrugelmir

coyrls said:

Audaxer said:

bowlhead99 said:

Audaxer said:
Great response Bowlhead. That reinforces my view that for income seekers, these sort of Investment Trusts are a better buy than equity income funds at this time, because although the funds might have similar yields to the ITs, there is less certainty that the funds will be able to maintain the same level of dividends in these uncertain times.

Yes, in a lean year they can simply sell out of some of their underlying investments to free up some cash to pay you the dividend, even if they don't receive much income for themselves.  So you would have a lower amount remaining invested than if they had paid you the natural income.

I thought in most cases the equity income ITs would still be able to continue to pay the dividends by dipping into their reserves built up to cover these times, so I didn't think the ITs like CTY would not need to sell any of their underlying investments to pay dividends?

The reserves are in the underlying investments.

Not helped by the fact it sits at a 4.5% premium to NAV currently.