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Income-starved investors in the UK are flocking to investment trusts, despite concerns that the strained sector could disappoint.

As dividend cuts across the market and poor returns leave many desperate for investment income, investment trusts are reporting increased interest. Six of the top 10 most popular funds purchased by retail investors on platform Interactive investor in May were trusts.

However, trusts have also suffered in the downturn and it is uncertain how many will be able to hold up their promise of using revenue reserves to smooth dividends if poor economic conditions persist. Eleven trusts have already cancelled dividends this year, many in the hard-hit property sector, while 20 have reduced or deferred dividends, according to data from the Association of Investment Companies.

“Revenue reserves are there for a rainy day. At present, it feels more like a thunderstorm,” said Robert Robertson, chairman of the Lowland Investment Company, speaking about its half-year results on June 5.

Lowland’s net asset values were down more than 30 per cent at the end of March, and earnings per share fell 35 per cent. Still, the trust plans to maintain its dividend.

Investment trusts are publicly traded, closed-ended vehicles. Shares in a trust trade at a premium or discount to the book value of their underlying assets. Unlike open-ended funds, trusts can hold on to profits from good years and draw on capital to smooth dividend payments in lean times, a model which has caught the eye of investors in the wake of the coronavirus crisis.

“We have had more questions from investors about revenue reserves and dividend cover in the past few months than in the past few years,” said Simon Elliott, an analyst at Winterflood Investment Trusts.

Ryan Hughes, head of active portfolios at investment platform AJ Bell, said: “Anyone in an open-ended fund is waking up quickly to the fact the income they’ve received could be down 30, 40 or 50 per cent on previous years.”

Mr Hughes noted that though investor take-up of trusts is likely to accelerate later this year, many open-ended funds are yet to announce the final cuts to their payouts, which might occur just twice annually. “Investors won’t truly react until they see a hit to their income,” he said. “We’ve only reached the eye of the storm.”

Many trusts are fiercely proud of their dividend payments. Each year, the AIC ranks “dividend heroes” or trusts that have increased their dividend every year for 20 years. Several hold multiple years of dividend payments in reserve.

Analysts say the next few months will be a moment of truth for investment companies, which have long extolled the virtues of their model for providing investors with consistent sources of income.

“If investment companies can come through on providing dividends, that will stand the sector in good stead,” said Mr Elliott. He noted that many trusts are well positioned to maintain their track records, increasing investor interest in the sector’s attractive yields.

Experts say that whether trusts will impress or disappoint will come down to the duration of the downturn. “If this continues into 2021 it is going to be very difficult for some investment trusts to maintain their dividend policy,” said Alasdair McKinnon, manager of the Scottish Investment Trust. “If the mainstream investment companies do start to struggle to meet their dividends, then there will be a reputational risk — you were supposed to be dividend heroes and that hasn’t been the case.”

Investment companies also expect that many corporations will use this year’s dividend cuts as an opportunity to rebase their payout ratios over the long term, straining trusts’ ability to meet investor expectations.

Investment trusts have never been as popular, or as large, as their open-ended cousins, which have 10-20 times more capital at play. Analysts note that wealth managers were not incentivised to recommend trusts to clients, and the “rainy-day” model means that trusts tend to pay out more conservatively than open-ended funds to prevent dividend payments rising so high they cannot be increased every year.

“Most set their dividend policies to reflect the long run, not individual good years,” said Mr McKinnon. “You don’t want to raise the bar unrealistically.”

“You’re never going to get the same interest as in open-ended funds,” said Monica Tepes, a research director at FinnCap whose work focuses on investment trusts. “But investors are looking for income from sources that you can have some degree of confidence are not going to be affected.”

Ms Tepes expects investors’ thirst for income to cause a rapid expansion in the sector. “Supply follows demand. As long as there is demand for income not satisfied somewhere else, there will be more investment trusts.”

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