During volatile market conditions and high inflation, investors are looking for ways to protect their income. Investment trusts have an income advantage which is particularly important for seekers of rising payouts.

This is because they are able to hold back up to 15% of the income they receive from their investments in their revenue reserves. They can use these reserves to boost dividends during lean spells when businesses may be cutting theirs.

This structural benefit has enabled many investment companies to pay consistently rising dividends through both good and bad years for many decades.

WHY A DIVIDEND HERO MIGHT SAVE YOU FROM STRIFE

You may have heard of the AIC’s ‘dividend heroes’, a cohort of 17 investment trusts with more than 20 years of consecutive dividend increases under their belts. An impressive seven of the dividend heroes have at least 50 years of unbroken annual increases, including City of London (CTY), which has raised its dividend consistently for 56 years.

Hot on its heels are global funds duo Bankers (BNKR) and Alliance Trust (ATST), alongside self-managed trust Caledonia Investments (CLDN), a trio which has achieved 55 years of unbroken dividend growth, while Global Smaller Companies (GSCT) and F&C Investment Trust (FCIT) have raised their dividend for 52 and 51 years respectively.

But what about the AIC’s next generation of dividend heroes? There are 28 trusts which have increased their dividends for more than 10 consecutive years but less than 20.

As Association of Investment Companies communications director Annabel Brodie-Smith observes: ‘These are the next generation of dividend hero investment companies, who have the potential to become dividend heroes in the future. Of course, dividends are never guaranteed and investors should do their homework before investing in these companies.’

WHO ARE THE NEW KIDS ON THE BLOCK?

Leading the pack on 19 years apiece are three funds from the AIC’s UK Smaller Companies sector, namely Athelney (ATY), BlackRock Smaller Companies (BRSC) and Henderson Smaller Companies (HSL).

By far the smallest of the trio, yet trading on the biggest yield of 4.6%, is the £4.3 million-of-assets Athelney, founded in 1994 and one of the 10 pioneer members of the junior AIM exchange in 1995. Managed by Manny Pohl, who seeks to uncover nuggets in the under-researched small cap market, the trust is invested in names as diverse as Games Workshop (GAW), Gamma Communications (GAMA:AIM) and AEW UK REIT (AEWU) and Pohl’s stock-picking prowess has allowed Athelney to increase its dividend each year since 2004.

Offering a near-3% yield and trading at a 16.7% discount to net asset value (NAV), BlackRock Smaller Companies boasts a rapid five year dividend growth per annum rate of 10.8% which reflects its focus on cash-generative smaller companies with attractive dividend growth rates.

As for Neil Hermon-managed Henderson Smaller Companies, it has outperformed its Numis Smaller Companies Index benchmark in 16 of the last 19 years, a period during which the shareholder reward has grown every single year.

The year to May 2022 proved a rare spell of underperformance as growth stocks de-rated due to the spike in inflation and rising interest rates. Sour sentiment towards the small caps sector leaves Hermon’s trust languishing on an 12.6%  NAV discount.

Also forging a formidable progressive payouts record is Artemis Alpha Trust (ATS), a UK All Companies constituent which has amassed 18 years of consecutive dividend hikes. Managed by John Dodd and Kartik Kumar, the fund has a five-year dividend per annum growth rate of 5.4% and top 10 holdings include the likes of Mike Ashley-controlled Frasers (FRAS), funeral services provider Dignity (DTY), low-cost carrier EasyJet (EZJ) and Japanese gaming giant Nintendo (TYO: 7974).

Co-manager Kumar says the trust has consistently grown its dividend ‘primarily by investing a proportion of the portfolio in income-generating companies and distributing income prudently.

‘Revenue earnings have grown in excess of dividends paid. In good years, this has meant that revenue reserves have been accumulated that can be used to cover shortfalls in tougher times.’

Kumar also notes that revenue earnings have covered the dividend in 14 of the last 19 years. ‘Currently revenue reserves per share stand at 11p, which is approximately 11 times the largest shortfall in earnings (2008) that there has been. So, we feel well placed to continue this pattern of raising dividends. The underlying net yield on the portfolio is over 2% and the yield on the share price is higher due to the discount. In comparison, 10-year inflation linked bonds offer a less than 1% return and unlike corporate earnings, by definition, cannot grow in real terms.

‘We hold many positions in the portfolio that do not pay dividends but have high earnings yields and/or growth potential. For these reasons, we expect our portfolio to offer attractive total returns and provide a hedge against inflation.’

INTERNATIONAL INCOME HUNTERS

The next generation heroes list also includes trusts clipping dividends from overseas stocks, with the abrdn-managed Murray International (MYI) on 16 years of rises in a row, followed by Henderson Far East Income (HFEL), Schroder Oriental Income (SOI) and BlackRock Greater Europe (BRGE) on the 15-year mark, where CQS New City High Yield (NCYF) keeps them company.

According to co-manager Samantha Fitzpatrick, Murray International has been able to deliver a steady, growing dividend to shareholders over many years due to the manager’s ‘unwavering focus on investing in good quality businesses with strong balance sheets, solid cash flows and progressive dividend policies’.

Murray International’s global remit ‘enables diversification at both the country and sector level’, stresses Fitzpatrick, which supports the dividend track record as ‘not all investments will face the same pressures and challenges at the same time.

‘Dividends paid to Murray International shareholders come from income earned from the trust’s underlying holdings as opposed to capital appreciation, making dividends less reliant on market moves and less vulnerable to market downturns.’

WHO ELSE MERITS MENTION?

Other noteworthy next generation heroes include infrastructure fund International Public Partnerships (INPP) on 13 years, where it sits alongside abrdn Asian Income (AAIF), and on 12 years, the likes of Fidelity Special Values (FSV) and UK Equity Income duo Lowland (LWI) and Law Debenture (LWDB).

Managed by contrarian investor Alex Wright alongside Jonathan Winton, Fidelity Special Values is the best 10-year share price total return performer in the UK All Companies sector, having returned 165.3%, and also boasts the sector’s highest five year dividend growth per annum rate of 12.5%. Fellow value fund Law Debenture is the best five-year share price total return performer in its sector with a near-34% haul and is up 134% over the last 10 years, ranking it the UK Equity Income space’s third best decade-long performer.

Trading on a 5.9% discount and offering 4.4% dividend yield, Law Debenture’s unique structure, with a cash generative professional services business (IPS) sitting alongside the trust’s diversified equity portfolio managed by James Henderson and Laura Foll, gives the managers greater stock-picking flexibility and has proven a winning long-run formula.

The trusts that have recently reached the milestone of a decade of dividend hikes in a row are Global sector constituents Mid Wynd International (MWY) and Lindsell Train (LTI) and also the Columbia Threadneedle-managed CT Private Equity (CTPE).

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