From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Ian Sayers, director general at the Association of Investment Companies (AIC), explains how new rules for investment trusts could mean more money in investors' pockets. If you are interested in Morningstar featuring your content, please email submissions to UKEditorial@morningstar.com.
There’s been a number of analyst reports so far this year demonstrating the superior performance of investment companies over unit trusts and OEICs. You may get a bumpier ride along the way but hopefully, if you stick with it, and hold a balanced portfolio, you’ll be rewarded over the long-term. But the new investment trust tax rules which came into effect this year have added yet more strings to the sector’s bow, particularly for income seekers.
Of course we’ve always trounced our open-ended counterparts when it comes to dividend track records. Investment trusts have the advantage of being able to keep back up to 15% of the income they receive each year and transfer this to their revenue reserves to distribute in leaner times.
Open-ended funds, by contrast, have to distribute their income every year. As BP (BP.) shows, even the strongest and most profitable companies can sometimes face events that cause them to have to reduce or even suspend their dividends. Having income in reserves can help smooth out these ups and downs, and is why many investment companies have increased their dividends literally for decades.
But, from this month, investment trusts have also been granted the freedom to distribute income from capital profits, which is good news for companies who do not have much in the way of revenue reserves but who do want to reward investors with a higher dividend yield. The first investment trust to explicitly state its intention to use the new tax rules to pay out a dividend using capital has been F&C Private Equity (FPEO). Cazenove wrote that “Not only does this result in an implied yield of 6.6%, it shows confidence on the outlook for cashflow.”
Of course, paying income out of capital profits won’t be for everyone, but anecdotal feedback from boards suggests that a number look set to embrace the new tax rules, particularly those who do not have sufficient revenue reserves to pay a higher income to investors.
With inflation showing little sign of retreating, interest rates still at record lows, and income in demand like never before, these new tax rules may well find favour with investors.
Ian Sayers is director general at the Association of Investment Companies (AIC). This article was provided by the AIC. The views contained herein are those of the author and not necessarily those of Morningstar.
