Guest blog by Frank Buhagiar

What does squash legend Jahangir Khan have in common with City of London, Bankers, Alliance and Caledonia investment trusts? They all occupy the top spot in their respective fields when it comes to winning streaks: Jahangir Khan recorded 555 consecutive wins between 1981 and 1986 which, according to Guinness World Records, is the longest winning streak by any athlete in top-level professional sports; while the above four trusts are joint top in terms of the number of consecutive years they have grown their dividends, having notched up a mightily impressive 50 years.
Beyond the top four, it turns out a Who’s Who of IT stalwarts are on their very own blistering runs. Six funds are well into their 40s: F&C Global Smaller Companies and Foreign & Colonial are on 46 years; Brunner 45 years; JP Morgan Claverhouse 44; Murray Income 43; and Witan 42. Other household names such as Scottish American are not far behind on 37 years; Merchants 35; Scottish Mortgage 34; and Temple Bar on 33.
But as all great sportsmen and women know, winning streaks come to an end. Even the great Jahangir Kahn’s run was ended by Ross Norman in Toulouse in 1986. So which of the 21 trusts listed by the AIC as having grown their dividends for 20 years or more ( are the most vulnerable? Making forecasts is of course a fool’s errand, but that’s not enough of a reason to not have a crack at identifying which of the income paying heavyweights are a little lightweight when it comes to being able to absorb a shock to their dividend-growing systems.
Of course, there are many variables at play when it comes to an investment trust’s dividends and since 2012 trusts have been able to pay dividends to shareholders from capital reserves i.e. profits generated from the sale of holdings. But this article is focusing on revenue return per share and revenue reserves. Revenue return per share is the trust equivalent of earnings per share. It doesn’t include capital returns generated by an appreciation in the value of a fund’s underlying holdings, only the revenue these produce for the investment trust via the income they pay out. Meanwhile, the revenue reserve comprises dividend income received in past years which has been retained by the investment trust. It is a rainy-day fund which allows the trust to make up any shortfall in the payout in any particular year.
As with companies, dividend cover can be used to determine whether an investment trust is living beyond its means: spending more in the form of dividends it pays out to shareholders than it earns. Dividing revenue return per share by the dividend per share gives us dividend cover. An analysis of the latest annual reports of the top 20 trusts shows most are net savers, i.e. the dividends they paid out are less than the revenues they received during the year. Among those that paid out more than they earned are Murray Income, Scottish American, Alliance, and Merchants. At 0.35, Scottish Mortgage has the lowest dividend cover having paid out 3p per share in 2017, while revenue return per share came in at 1.07p.
As mentioned earlier however, an investment trust can live beyond its means thanks to the revenue reserve which can be used to supplement dividends. Referring back to the latest annual report provides a guide on how much distributable reserves investment trusts have left in the tank. Divide revenue reserves by the dividend paid and the resulting “reserve cover” gives an indication on how many years’ worth of dividends could be funded from reserves. In reality, revenue reserve can sustain a dividend for considerably longer than indicated by reserve cover, as typically it is used to top-up the annual payout from time to time, rather than fully fund a year’s worth of dividends.

In terms of reserve cover, the leaders of the pack include Club 50 member Caledonia which, according to its latest Annual Report, has distributable reserves “broadly equivalent to over 60 years payment of the current annual dividend”. Scottish Investment Trust is also sitting pretty with a reserve cover of over three times. And at between 1.5 and 2 times, the dividends of Alliance, Witan, Foreign & Colonial and Brunner all look to be in relatively good shape.

However, this exercise is more concerned with those trusts that are not flushed with reserves. Interestingly, Merchants and Scottish Mortgage, both of which paid out more than they earned in the last financial year, feature at the bottom of the reserve cover list: Merchants has cover of 0.43; while Scottish Mortgage is on just 0.16. Of course one swallow does not make a summer, but in the case of Merchants two might, as this was the second year that the investment trust dipped into its reserves, albeit not by a large amount. With reserve cover of just 0.16, it won’t be a surprise to learn that Scottish Mortgage has relied on its revenue reserves to grow its dividends in each of the last five years. Clearly, this can’t go on forever and the Company itself recognises this, as the following excerpt from this year’s Chairman’s Statement shows:

“Absent a significant (and unexpected) uplift in income from the portfolio, next year the Board will be obliged either to cut the dividend or to make use of its power to continue to pay a comparable dividend, supplemented from capital profits as well as the remainder of the revenue reserve.”

We might not have long to wait to find out if Scottish Mortgage will be the first “dividend hero” to trade in its winning streak for a mean streak – will it be a case of 34 all out?