Income Growth For The Lazy Investor

You don't need to be a financial wizard to build a growing stream of dividends.

A couple of years ago, I set out a minimum-effort income strategy. It was designed as an alternative to an annuity for those prepared to accept the risks of equity investment. The objective was simple: to deliver a growing stream of dividends.

The strategy taps the average dividend-generating capacity of a mundane basket of investment trusts, which are similar to unit trust/OEIC funds but listed on the stock market. In my original article, I constructed a sample portfolio to demonstrate the approach and I've since been tracking it to see how well it meets its objective.

Ten trusty trusts

A characteristic of investment trusts is that they don't have to distribute all their annual income. Many run a 'revenue reserve', which they add to in times of abundance and draw on in times of famine. The idea is to pay a growing dividend to their shareholders through thick and thin.

In constructing my demo portfolio, I sought out trusts of a reasonable size (market capitalisation) and with a reasonable dividend yield. I also looked for a good history of rising dividends (at least 10 years), a stated objective of increasing dividends in the future and a reasonable revenue reserve to draw on should circumstances demand.

I selected a portfolio of 10 trusts, the core of which came from the UK Growth & Income sector. I also threw in a UK Growth trust that was on a reasonable yield and a couple of trusts with a global mandate, just for variety.

Dividend growth

In the table below, the final column shows the dividend growth in the year to 9 March 2012; the other columns show annual dividend growth in the preceding four years on a like basis.

^{* Denotes a 20+ year record of increasing dividends.
** Temple Bar's large increase in 2011/12 was as a result of a one-off rebalancing of its interim and final dividends.}

As the table shows, over the past five years the investment trusts have continued their long records of growing their dividends, including through the 2008/09 recession -- a time when many income investors in individual blue chips were reporting falls in excess of 30% in the income of their portfolios.

However, it should be noted that, in the most recent two years, while the trusts' average growth has continued to be positive in absolute terms it has modestly undershot inflation.

The sub-inflationary growth of the last two years has been due to trusts' self-restraint while dipping into their revenue reserves; and, more recently, as dividends from their underlying holdings have improved, to some trusts beginning to replenish, or reinforce, their reserves rather than passing the full income on to shareholders.

In the coming year, the prospect of a return to dividend growth ahead of inflation looks promising on the face of it, particularly as inflation appears to be moderating. However, much will depend on how aggressively trusts channel revenue into their reserve pots.

I suspect many trusts may deem it prudent to give shareholders no more than an in-line-with-inflation dividend increase this year, because economic recovery remains fragile and interest on cash and gilt yields are so pitiful.

Still attractive?

Is the basket of 10 investment trusts I selected in 2010 still attractive to income seekers today? The share prices, trailing yields and dividend cover by revenue reserve of the trusts at 9 March 2010 and today are shown in the table below.

^{* Temple Bar's yield has been adjusted to take account of the one-off rebalancing of its interim and final dividends.}

The current revenue reserves remain respectable, despite the majority (and the average) being lower than two years ago. All are above F&C Capital Income's 79% that I found borderline acceptable in 2010.

The current average yield on the portfolio, 4.3%, compares with 4.5% in March 2010 (and 4.2% in March 2011). For a spell in the second half of last year it rose to a very attractive 4.8%.

Currently, then, the yield is nearer the lower end of the range seen in the past few years, though it still compares favourably with the FTSE All-Share's 3.4%.

Robust and bountiful

In my view, the basket of investment trusts has done a decent job of delivering income through the whirlwind of company dividend cuts that followed the credit crunch.

If a few years of sub-inflationary income growth through 'the worst economic crisis since the 1930s' is as bad as it gets, the strategy will have shown itself to be as robust in foul weather as it has been bountiful in fair.

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