Interesting comments on future dividends

[Luniversal]

At the end of last month, Edinburgh 's ten largest holdings as revamped by Mr de Uphaugh included Tesco, Legal & General, Direct Line, AstraZeneca and Unilever: all decent yielders and/or growth-of-income plays. The revenue account is juiced by Anglo and other miners, the biggest sectoral exposure. Diggers' dividends are cyclically variable but generally stack up over time.

Muttering about a slow recovery has become boilerplate management of expectations among IT directors in the latest round of reports. I see no special reason to mark EDIN's prospective yield down.

In today's climate for savers, a high initial return plus an intact record of not cutting dividends stretching back through previous crises is a tremendous selling point. EDIN will not lightly do a Shell; not after more than forty years with no worse blemish than two freezes in the early 2000s.

[jonesa1]

I hold four of the candidates, JCH, MRCH, MUT, CTY, all fishing in the same pool. All were selected for their long records, which logically they will defend to the last shillings and pence of their reserves.
Wishful thinking? We shall see.

V8

Those reserves are simply part of the IT's NAV, they're not usually held in cash, it's just an accounting device which allocates part of the NAV to the reserve. In order to use that reserve the IT needs to either sell assets or increase borrowing (both will lower the NAV). It may be more cost effective (and less admin) for the IT to liquidise assets to pay a dividend, than for investors to sell assets themselves, but maybe realising a capital gain will result in a lower tax liability for some than receiving the proceeds as a dividend. Either way, getting an income above that covered by the dividends the IT receives, depends on utilising capital. I can't help but feel that the IT dividend reserves are nothing more than smoke and mirrors, especially as these days ITs can pay dividends from capital (as many already do, e.g. European Assets, JPM Global Growth and Income).

Andrew

[Dod101]

I hold four of the candidates, JCH, MRCH, MUT, CTY, all fishing in the same pool. All were selected for their long records, which logically they will defend to the last shillings and pence of their reserves.
Wishful thinking? We shall see.

V8

Those reserves are simply part of the IT's NAV, they're not usually held in cash, it's just an accounting device which allocates part of the NAV to the reserve. In order to use that reserve the IT needs to either sell assets or increase borrowing (both will lower the NAV). It may be more cost effective (and less admin) for the IT to liquidise assets to pay a dividend, than for investors to sell assets themselves, but maybe realising a capital gain will result in a lower tax liability for some than receiving the proceeds as a dividend. Either way, getting an income above that covered by the dividends the IT receives, depends on utilising capital. I can't help but feel that the IT dividend reserves are nothing more than smoke and mirrors, especially as these days ITs can pay dividends from capital (as many already do, e.g. European Assets, JPM Global Growth and Income).

Andrew

This has been covered again and again these last few weeks and there is no point in covering the ground again. However for those who rely on dividends for income to live off, the smoothing mechanism of the Revenue Reserves which ITs usually hold can be helpful. It is not of course a long term answer for a shortfall in revenue and the release of realised capital gains is not either if an IT claims to be primarily an income trust.

On the subject of Edinburgh IT, I have held it for more than 25 years and it has been a quietly dependable investment, and I like the general style which is modest and honest. I think it is in that context that the Chairman's remarks are made. I see that two of their long serving directors are due to retire soon, Max Ward, MD of the Independent IT and Gordon McQueen ex Bank of Scotland (whilst it was still an independent bank) They will surely be missed but as I have said many times, Directors tend to recruit those who are ' one of us' and thus the culture is preserved. Whether they maintain or increase their dividend will depend obviously on what the shortfall amounts to and how long it is likely to last.

Slightly surprising that the Chairman mentions Majedie's total return style and that would tend to suggest that they do not see much future in concentrating on income which is what did for Mark Barnett.

Dod

[Alaric]

I can't help but feel that the IT dividend reserves are nothing more than smoke and mirrors, especially as these days ITs can pay dividends from capital (as many already do, e.g. European Assets, JPM Global Growth and Income).

The rules governing ITs allow dividends to be maintained without the investor having to make asset sales. That is a probably a attribute valued by at least some investors. By contrast, dividends on ETFs tracking UK markets have plummeted and OEICs will no doubt follow suit unless they can themselves indulge in smoke and mirrors. I'm thinking that they may have switched some of their holdings into the "competition" namely ITs, or indulge in the buy "cum" sell "ex" method of creating dividends to distribute.

[jonesa1]

The rules governing ITs allow dividends to be maintained without the investor having to make asset sales. That is a probably a attribute valued by at least some investors.

An attribute which doesn't depend on a revenue reserve, just a willingness to distribute a portion of the dividend from the capital assets. I'm not quibbling about the benefits of leaving it to the IT to manage the conversion of capital to income, I am quibbling about the revenue reserve being anything more than marketing.

[Dod101]

The rules governing ITs allow dividends to be maintained without the investor having to make asset sales. That is a probably a attribute valued by at least some investors.

An attribute which doesn't depend on a revenue reserve, just a willingness to distribute a portion of the dividend from the capital assets. I'm not quibbling about the benefits of leaving it to the IT to manage the conversion of capital to income, I am quibbling about the revenue reserve being anything more than marketing.

The Revenue Reserve has got nothing to do with marketing. Why would you say that? It is an accumulation of the part of the revenue not distributed each year. It is probably rather less important now than it was in the days before ITs were allowed to distribute realised capital reserves but it still adds to those reserves which are distributable and are usually the first call if an IT wants to augment its current earnings in order to maintain a dividend record. You may not care but many investors in IT welcome the ability of an IT to increase the dividend distribution each year.

Dod

[jonesa1]

Dividends not paid out are added to the capital base. They aren't in a separate account, or set of investments, it's just an allowance in the accounts for an accumulated reserve. In the days before ITs could pay dividends from capital sales, this reserve allowed them to do just that. Now ITs don't have that restriction. A decision to top up dividends from the reserve is indistinguishable from a decision by the board to simply sell assets (or borrow) without an accounting reserve. In both cases the NAV decreases. All that matters is that the board are willing to reduce NAV to top up dividends (probably not such an easy decision after a market fail if values stay down). That's why I described the revenue reserve as marketing, which is how it's actually used, extensively.

[Wizard]

Dividends not paid out are added to the capital base. They aren't in a separate account, or set of investments, it's just an allowance in the accounts for an accumulated reserve. In the days before ITs could pay dividends from capital sales, this reserve allowed them to do just that. Now ITs don't have that restriction. A decision to top up dividends from the reserve is indistinguishable from a decision by the board to simply sell assets (or borrow) without an accounting reserve. In both cases the NAV decreases. All that matters is that the board are willing to reduce NAV to top up dividends (probably not such an easy decision after a market fail if values stay down). That's why I described the revenue reserve as marketing, which is how it's actually used, extensively.

There is though potentially a psychological aspect as well. While the Directors can now sell any assets to release capital to pay out to shareholders that may be a hard line to cross for an income fund. However, by continuing to track the proportion of capital that was created by holding back income received it means there is a buffer they may feel happier using, as they justify it as the deferred payout of income.

A question I have is how is the reserve tracked? If a fund receives a dividend income of 100 in year 1, but only pays out 90, they create an income reserve of 10 which is invested. In year 2 the NAV of the fund falls by 10%. Do they report an income reserve of 10, or 9, or a different number because they have separately tracked the performance of what they invested the initial 10 in?

[Arborbridge]

Dividends not paid out are added to the capital base. They aren't in a separate account, or set of investments, it's just an allowance in the accounts for an accumulated reserve. In the days before ITs could pay dividends from capital sales, this reserve allowed them to do just that. Now ITs don't have that restriction. A decision to top up dividends from the reserve is indistinguishable from a decision by the board to simply sell assets (or borrow) without an accounting reserve. In both cases the NAV decreases. All that matters is that the board are willing to reduce NAV to top up dividends (probably not such an easy decision after a market fail if values stay down). That's why I described the revenue reserve as marketing, which is how it's actually used, extensively.

I'm not qualified to talk about the accounting in this case, however, I had cause to talk with people running an ETF which paid out income and they explained that it was in effect a marketing driven choice. That is, they could maintain or increase the dividend, or re-invest and not pay it out. It all depended whether the marketing department wanted the TR chart to look good, or the record of increasing dividends, likewise.

Arb.

[Dod101]

A question I have is how is the reserve tracked? If a fund receives a dividend income of 100 in year 1, but only pays out 90, they create an income reserve of 10 which is invested. In year 2 the NAV of the fund falls by 10%. Do they report an income reserve of 10, or 9, or a different number because they have separately tracked the performance of what they invested the initial 10 in?

The income (revenue) reserve stays at the original 10. It is a monetary amount, unchanged by fluctuations in the value of the assets it is invested in.
The difference is accounted for on the other side of the Balance Sheet in unrealised changes in the value of the underlying assets or some such phrase

To answer jonesa1, I am well aware of what you say but the fact is that many investors like the idea that an IT does not have to make use of its capital reserves to augment a dividend payment and instead can use the accumulated revenue reserves for this purpose. It is a marketing ploy but so what? It is part of the remit of Directors to produce an attractive environment for investors to buy and hold their shares. I suspect that most investors in ITs do not care where the dividend comes from in the books of the IT, simply that the dividend keeps increasing each year.

Dod

[Itsallaguess]

A decision to top up dividends from the reserve is indistinguishable from a decision by the board to simply sell assets (or borrow) without an accounting reserve. In both cases the NAV decreases. All that matters is that the board are willing to reduce NAV to top up dividends (probably not such an easy decision after a market fail if values stay down).

That's why I described the revenue reserve as marketing, which is how it's actually used, extensively.

But it's still a set of decisions that owners of income Investment Trusts do not have to make, and given that many income-investors are attracted to these sorts of IT's with an actual aim to 'sub-contract out' many of the tiresome portfolio-level processes that more direct share-ownership often entails, then I think credit should still be given to these revenue-reserve processes with that intent clearly in mind..

It's not too much of an argument to just say 'you could do this yourself', when one of the primary reasons many income-investors often head towards income-IT's is to simply reply 'but I'm actually quite happy for someone else to, thanks...'

Cheers,

Itsallaguess

[jonesa1]

It's not too much of an argument to just say 'you could do this yourself', when one of the primary reasons many income-investors often head towards income-IT's is to simply reply 'but I'm actually quite happy for someone else to, thanks...'

Cheers,

Itsallaguess

I completely agree (and hold a number of income ITs myself). I do suspect however, that many retail investors don't understand the choice they are making and take the marketing hype about revenue reserves at face value. Presumably that doesn't apply to many of the contributors to TLF, who will have made an informed choice.

[Wizard]

Different IT, somewhat different tone in these comments...

https://investegate.co.uk/scot-inv-trus ... 00078548P/

We have unquestionably entered a more difficult environment for income generation given the curtailment of dividend payments across the stockmarket. However, we have long prepared for such a scenario by building, during more plentiful periods, a substantial revenue reserve amounting, at this interim stage, to more than 2.5 times last year's regular dividend.

The Board's intent with regard to dividends remains unchanged. The Board aims to maintain the Company's long track record of annual regular dividend increases and also its objective to provide regular dividend growth ahead of UK inflation over the longer term. Accordingly, the Board will, subject to shareholder approval, pay an increased regular dividend for the year ending 31 October 2020 which would be the 37th year of consecutive annual increases. 

The Board announces a second quarterly dividend of 5.7p. The target is to declare three quarterly interim dividends of 5.7p in the year to 31 October 2020 and to recommend a final dividend of more than 5.7p for approval by shareholders at the Annual General Meeting in 2021. The first quarterly dividend payment, in respect of 2020, of 5.7p was made in May 2020. 

But this is not the highest of yielders, despite the name, at c.3.2%. The income reserve, not withstanding recent discussion of the concept seems sizeable. Currently NAV is rising, but share price falling, widening the discount to NAV to over 12%, so seems to be some concerns in the market.

[Luniversal]

"But this is not the highest of yielders, despite the name, at c.3.2%. The income reserve, not withstanding recent discussion of the concept seems sizeable. Currently NAV is rising, but share price falling, widening the discount to NAV to over 12%, so seems to be some concerns in the market."

Scottish (SCIN) had a revenue reserve worth 34 months of current payout at Oct. 2018. It had been as high as 47 months in Oct. 2011, but the dividend has been bumped up.

All my 'Growth Ten' hold large reserves except Scottish Mortgage, which is no longer committed to a rising payout. Monks looks upon divis as a minor irritant, but reserves at the other eight's latest financial year ends average two years: twice the size of those for my income 'baskets'.

Given this strength, the emphasis on investing in regions where dividend slaughter has been less savage and the sector's increasing urge to appeal to savers (seven of the G10 now pay quarterly), it is becoming more of a Global Income & Growth proposition.

Scottish switched to the newish Global Equity Income sector and is repositioning itself as a one-stop shop. Law Debenture and Scottish American seem to be heading the same way.