Citywire’s Richard Lander sat down with Guy Anderson, manager of the Mercantile Investment Trust, to discuss the ins and outs of the fund in a three-part series. The second segment discusses the dramatic cuts in dividends seen this year and why investment trusts can be the ideal vehicle to weather such events
With interest rates at historic lows, income is a precious commodity for investors. But this year delivered a nasty shock as, at the peak of the Covid crisis, companies started to slash their dividend payments.
But as Guy Anderson points out, well-managed investment trusts have been able to cushion the blow, thanks to their ability to store up income reserves in strong markets, enabling them to smooth the dividend profile for their investors over time.
‘This is what makes investment trusts the ideal vehicle for the preservation of vital income,’ he says. ‘Taking Mercantile as an example, the trust has grown its annual dividend at an 8.5% compound annual growth rate over the last 30 years, which clearly demonstrates the income credentials both of this vehicle and the market in which we invest.’
The environment during the second quarter of 2020 was exceptionally brutal for companies. ‘At the height of the crisis, many businesses had to shut down and needed to preserve their cash so that they could remain viable operations. Their only realistic option was to make substantial dividend cuts: for FTSE 100 companies, Q2 dividends were cut by around 45%, while for mid-caps, as reflected by the FTSE 250, Q2 dividends were cut by around 76%.’
From a pure investment perspective, Anderson does not make investments specifically for the dividend- rather, it is a by-product of the investment case, which is focused on long-term capital growth.
‘Nevertheless, we realise that income is very important for our investors, and, because we had built up substantial dividend reserves over the years, our board was able to come out with a confident message as we delivered interim results in October. It stated that, despite the substantial hit to income during the crisis period, it would look to maintain at least the same dividend level as last year.’
As the economy gradually began to re-open, it was also gratifying to note the resilience of the trust’s underlying investment market, he says. ‘After coming out of that period, we saw businesses starting to pay dividends again as their operations restarted and they were able to operate profitably,’ he says.
But the crisis may have forced a market-wide re-think of the importance of dividends relative to the structure of an overall business, one that Anderson welcomes as it is in line with his own long-term view.
‘There’s a lot more to a company’s return profile than just the income. If investors focus solely on the income, it’s possible that they miss out on other things. What we’ve seen is that a certain cohort of the market were potentially over-paying in dividends and thus not investing enough in their own businesses.’
While companies clearly have to walk a difficult tightrope between dividend payments and investing in their own futures, Anderson thinks the crisis has given many the opportunity to reset their income at what seem more sustainable levels. ‘That should ultimately drive future growth, which for me is the most exciting part of the business case,’ he says.
In the end it’s more important to think first about the underlying economics of a business, rather than being tempted by what seems a gratifying dividend yield, he emphasises.