Reassurance for income investors during dividend drought

It is not a particularly good time to be an income investor. Some of largest dividend payers in the UK have cut payments entirely, with banks the latest to slash outstanding payments in order to shore up their finances and support the country in the battle against the COVID-19 pandemic.

The largest 100 UK companies have cut payouts to shareholders by almost £24bn since the pandemic struck, according to AJ Bell, with major players such as BT and Shell suspending payments for the first time in many years.

It makes one wonder where to turn to, especially for those in retirement and living off the income provided by a dividend-reliant investment portfolio.

This is where one of the key benefits of an investment trust shines through. Unlike open-ended funds, which have to pay out all income accrued in any given year, the closed-ended structure allows trusts such as Alliance Trust PLC to hold back income and build up a reserve fund. These reserves are grown in the good times, when markets swing upwards and the investments perform well, to make sure cash is available in more difficult times, even if the value of underlying holdings falls.

This reserve pot means a trust should be able to maintain, or even grow, its dividend every year.

To assess how well covered a trust is, an investor can examine the amount it has in its reserves, then look to its dividend cover to analyse how many times the dividend can be paid from the reserve pot, even in times when new income from its investments is scarce. The higher the dividend cover, the better able the trust is to pay its dividends in difficult periods.

Analysis conducted by AJ Bell, reveals that Alliance Trust is one of only two investment trusts with ‘Dividend Hero’ status to have enough in reserve to pay more than two years of dividend payments from reserve funds alone.

With £109.6m in reserve, Alliance Trust has a dividend cover equivalent to 2.38 years. The only other trust to have enough to cover for more than two years is the Scottish Investment Trust, with £52m in reserves covering 2.35 years of dividend payments.

In its annual report published in March, Alliance Trust highlighted the fact that it has increased the dividend paid to its shareholders for 53 years in a row. The Board recognises the importance of rising dividends, particularly during difficult times when so many companies are cutting or cancelling their dividends to protect their balance sheets.

The trust intends to continue its record of annual dividend growth into a 54th year. Its progressive dividend policy was overwhelmingly endorsed by shareholders at its Annual General Meeting in April.

While dividends are never a cast-iron guarantee, Alliance Trust’s position as a Dividend Hero – an accolade marking the fact we have increased dividend payments for 53 consecutive years – as well as its reserve pot to cover dividends, should offer some reassurance to investors in this difficult time.