Where has my income gone?

Where has my income gone? is a question many investors are asking as UK dividends are cut but at least investment trusts have revenue reserves to draw on.

It looks as though we are about to lose another Dividend Hero as Temple Bar says it will cut its dividend by around 25% (to 38.5p from 51.4p) after 36 consecutive years of dividend increases. That will come as a blow to those shareholders that are reliant on their dividend income, but it may not be too much of a surprise, given that dividends for the UK market are forecast to be 40% lower in 2020 versus 2019.

When you look at the numbers, Temple Bar’s revenue account appears to have been hit particularly badly. Investment income for the six months ended 30 June 2020 was £8.1m, 64% less than the figure for the equivalent period in 2019. That flows through into revenue earnings per share of 9.25p, down from 30.3p.

Temple Bar has already declared two quarterly dividends of 11p each for the current financial year. Paying these uncovered dividends meant that the trust’s revenue reserves at the end of June had fallen to £23.7m from £37.1m at the end of December 2019. While it has permission to make distributions from capital reserves if necessary, the board doesn’t want to go down this route. The next two quarterly dividends will be 8.25p therefore.

The dividend cut comes alongside a proposed change of manager for the trust. We wrote a note this week that aims to explain what is happening, you can read that here.

With market cap of £436m, Temple Bar is the seventh-largest trust in the UK equity income sector. The fifth and sixth-largest trusts, Perpetual Income & Growth and Murray Income, are set to merge.

We have Charles Luke, who will be the manager of the combined trust, coming onto the show on 16 October. Murray Income announced its results for the year ended 30 June 2020 this week. Fortunately for its shareholders, it felt able to grow its dividend for the 47th year in a row. It is not a huge jump – just 0.7% – but it is symbolic of its determination to persevere through the current crisis.

The trust’s 34.25p dividend for the year compares to earnings of 30.5p. These were 12.6% down on the prior accounting year. The situation will be helped a little next year as the overall fees are forecast to be lower post the merger but the effect of this is marginal, about a tenth of 1% per year. Investors’ preoccupation with fee levels is often misplaced we think. Decent outperformance can dwarf running costs.

Murray Income used about £2.8m of its revenue reserves to support its dividend for the year ended 30 June and still has £22.2m left. However, a technicality in the way that the merger is being executed means that Perpetual Income & Growth’s revenue reserves will be wiped out (in accounting terms only – effectively they’ll be turned into a capital reserve). Murray Income’s revenue reserve per share will roughly halve, therefore. To address this issue, its board intends to ensure that the trust can make distributions from capital if necessary – this seems entirely sensible to us.

On a capital basis, returns for Murray Income over the period were not too bad. The NAV total return was negative, -5.3%, but that was a lot better than the -13% return posted by its benchmark. The manager says that reflects his emphasis on investing in high quality companies. While some of these companies have been hit hard by COVID, they should have relatively strong balance sheets to help them get through the worst of this.

Murray Income’s Dividend Hero status is secure for another year at least. Managers of UK equity income funds are being tested by COVID. Most managers that we talk to say companies will not be as quick to reinstate dividends as they were to cut them. Revenue reserves can help many trusts get through the worst of this. However, without the ability to store up income for a rainy day, open-ended funds are slashing dividends, often by far more than the 25% cut proposed for Temple Bar.

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