Income Investment Trusts - are these the times they (relatively...) shine?

[Itsallaguess]

Again using CTY which has a 5% yield and perhaps will only get income equivalent to 3% yield that means CTY needs to find/borrow sell 2% of its value this year, if the income doesn't recover next year or the following will they keep borrowing or selling value to cover that shortfall, or have to rebase the dividend.

So for me to copy that model I'll run up my credit cards or overdraft for the next couple of years before selling holdings and finally cutting my withdrawals.

So the attraction of an IT for their income reserve rather than my directly invested portfolio is imaginary and we're just paying fund managers because they're better investors.

Which is fair enough and it does spread manager risk. But with CTY following the FTSE100 for the past few year it'd be cheaper to buy the index for what extra benefit?

I'm not sure that anyone would suggest that any single 'potential advantage' that income-investors might seek by using income-IT's to help deliver their investment-income can't be 'manually-replicated' by an investor in one way or another if they are determined enough to do so..

The single biggest advantage for income-IT's to me, however, is that there's lots of those 'potential advantages' all at the same time, and it's when I take them all into account that things start to look really appetising -

• 'Hands off' income-reserve management
  
• 'Hands off' broad market-diversification
  
• 'Hands off' discount-control mechanisms
  
• 'Hands off' ongoing income-portfolio management
  
• 'Hands off' market analysis

There's possibly a couple more, but I think that'll probably do for now, and I hope raises the point that 'income-reserves' on their own are just part of the story really, and I can only speak for myself, but as my income-portfolio grows, I do very much enjoy all of those 'Hands off' benefits being available in an 'off-the-shelf' solution...

I'd also probably add that trying to quantify any 'potential benefits' that income-IT's might deliver over the coming months or longer, as we move through this particularly tough market period, is going to be fairly difficult whilst we're smack bang in the middle of it, similar to the problems that they've got with their virus-infection modelling - there's simply too many balls in the air at the moment...

It's likely that we're only going to get a full picture of how this plays out when we're on the other side of the problem, and the majority of single-company dividend issues have begun to properly work their way out, rather than still being announced as they are at the current time...

It's early days yet...

Cheers,

Itsallaguess

[Dod101]

IAAG's points are valid but I suspect that if the dividend shortfall becomes prolonged CTY is no more immune than the rest from having to freeze or even cut its dividend. As for the other points, I think the instant diversification is probably the most attractive aspect of the typical IT. The Revenue Reserve can only be a short term bridging facility at best although they can of course also distribute Realised Capital Reserves but that is obviously eating in to capital assets which is fine in a rising market.

Dod

[Itsallaguess]

IAAG's points are valid but I suspect that if the dividend shortfall becomes prolonged CTY is no more immune than the rest from having to freeze or even cut its dividend.

As for the other points, I think the instant diversification is probably the most attractive aspect of the typical IT.

The Revenue Reserve can only be a short term bridging facility at best although they can of course also distribute Realised Capital Reserves but that is obviously eating in to capital assets which is fine in a rising market.

Totally agree Dod, and I made that point myself on the first page of this thread -

If we see a technical recession for global health reasons, and it's a relatively 'short-sharp-shock' with a resulting u-shape recovery, then that was just the scenario I was suggesting might be a good time to take advantage of the income-reserves being held by the majority of income-related Investment Trusts.

If any such recovery were a more prolonged affair, then of course those Investment Trusts would come under pressure trying to maintain payouts, so this is really around the idea that perhaps any of the expected revenue-shocks might be cushioned somewhat by IT income-reserves, and they are perhaps there precisely for these types of situations..

https://www.lemonfool.co.uk/viewtopic.php?f=31&t=22053#p290502

Cheers,

Itsallaguess

[tikunetih]

• 'Hands off' income-reserve management
  
• 'Hands off' broad market-diversification
  
• 'Hands off' discount-control mechanisms
  
• 'Hands off' ongoing income-portfolio management
  
• 'Hands off' market analysis

I don't use Income ITs myself, but like other collective investment vehicles, a key benefit is to place the market more at arms-length.

The more arms-length the market, the easier the journey for an investor. Of itself that is preferable to a more difficult journey, but also because an easier, less stressful journey makes an investor less liable to make a mistake (act emotionally) when under pressure.

For example, an investor who runs their own directly-held equities portfolio must (or at least may) wake up each morning to read another RNS describing tough trading conditions and maybe cut dividends. You could imagine an investor may come to dread reading their emails as the litany of bad news takes its toll on their outlook. Perhaps in time this causes them to despair of a recovery, abandoning their investment plan.

In contrast, the owner of a collective investment vehicle can retain a helicopter view, leaving the day-to-day exposure to and analysis of individual holdings to the manager of an active fund, or ignoring such things completely if using an index fund.

This outsourcing of responsibility to someone/something else, and the distancing it enables, can amount to a big deal, whether that simply makes for a more pleasant investment experience or whether it stops someone from making a big mistake and abandoning their plan at a critical time. For many, the slight cost increase of using a collective can be money very well spent.

[kempiejon]

There's possibly a couple more, but I think that'll probably do for now, and I hope raises the point that 'income-reserves' on their own are just part of the story really, and I can only speak for myself, but as my income-portfolio grows, I do very much enjoy all of those 'Hands off' benefits being available in an 'off-the-shelf' solution...

Yes it was just the income reserve part of the IT shines that I was questioning as for a few replies above mine it turns out that what I might have thought of as an income reserve was just availability of an overdraft or having to sell down capital to realise money to pay that income. I like collectives for those other benefits and for that reason I've bought them.

[Itsallaguess]

The more arms-length the market, the easier the journey for an investor.

Of itself that is preferable to a more difficult journey, but also because an easier, less stressful journey makes an investor less liable to make a mistake (act emotionally) when under pressure.

For example, an investor who runs their own directly-held equities portfolio must (or at least may) wake up each morning to read another RNS describing tough trading conditions and maybe cut dividends.

You could imagine an investor may come to dread reading their emails as the litany of bad news takes its toll on their outlook.

Perhaps in time this causes them to despair of a recovery, abandoning their investment plan.

Heh - Amen to that....

Cheers,

Itsallaguess

[Itsallaguess]

I've now only just realised that I can add the additional 'Reserve Cover' figure for these income-Investment Trusts to my AIC data-tables, so I'll make sure I do that for future releases.

Replying to myself here, but just to let people know that the April 2020 Income-Investment Trust yield table has now been updated to include the 'Reserve Cover' (Dividend Cover in Years) data -

https://www.lemonfool.co.uk/viewtopic.php?f=31&t=22720

With grateful thanks to John for helping out with the update.

I'll make sure to also include it in future updates.

Cheers,

Itsallaguess

[Itsallaguess]

Yes it was just the income reserve part of the IT shines that I was questioning as for a few replies above mine it turns out that what I might have thought of as an income reserve was just availability of an overdraft or having to sell down capital to realise money to pay that income. I like collectives for those other benefits and for that reason I've bought them.

When you say 'sell down capital to realise money' though, do remember that this would be 'selling down capital' of the income-reserve, so it's not that they don't have one - the discussion was really around the fact that to sell some of that 'income-reserve' in some scenarios might well be choosing to sell into a lower market to do so...

That doesn't remove the fact that there *is* an income reserve, but it just might not be in the 'pure cash element' that such a phrase might normally invoke...

The discussion then went on to raise the point that, actually, if they've got credit-facilities too, that would also give another cash-raising option, which along with the option to sell some of the actual 'reserve', gives them some flexibility in terms of the top-up methods they might employ in any given set of circumstances.

So it's only viable to then say 'well I can do that myself' if you're actually prepared to always 'carry' some equity-reserve yourself too (or a cash element instead...), and also prepared to consider some sort of loaning-facility as an additional top-up option too...

It was an important point to raise though regarding the 'reserve' element, and I'm grateful it was raised, but we should also probably remember that even if this 'reserve-element' *was* held as actual cash (which might have then satisfied your own position on this, perhaps?), then given that under 'normal-circumstances' such 'cash' funds would then just 'sit-idle' where they are not actually required, then we might consider that such potentially considerable sums could actually be 'losing money' during what we would hope are the much more common 'normal market years' where, if such funds *were* to be held as equity, they would be going on to provide a 'compound-benefit' by being in that 'normal-market' and taking advantage of it..

My point with that is to say that I don't suppose we can have it both ways with this particular element of 'reserve benefit', and again I'd make the point that even in 'market-duress' situations, it's unlikely that these income-IT's are going to lose 100% of their own underlying dividend-income anyway, so there will always be some tunes to be played in terms of how they themselves try to top-up their own payouts during these periods...

Cheers,

Itsallaguess

[77ss]

.....
That doesn't remove the fact that there *is* an income reserve.....

Unfortunately, calling something an 'income reserve' doesn't mean diddly on its own.

As I have moved into ITs away from HYP my attention has been on diversification rather than yield and to that end I added a new sector, buying 2 private equity trusts (BPET & SLPE). Both are (now) clearly in the high yield division and, to date, seem to have no trouble paying (and increasing) their dividends.

Neither have any 'income reserves' whatsoever - something I am now feeling rather more relaxed about.

Parenthetically, I speculate that in these turbulent times PE might be a good pace to put some more money.

[Itsallaguess]

That doesn't remove the fact that there *is* an income reserve.....

Unfortunately, calling something an 'income reserve' doesn't mean diddly on its own.

As I have moved into ITs away from HYP my attention has been on diversification rather than yield and to that end I added a new sector, buying 2 private equity trusts (BPET & SLPE). Both are (now) clearly in the high yield division and, to date, seem to have no trouble paying (and increasing) their dividends.

Neither have any 'income reserves' whatsoever - something I am now feeling rather more relaxed about.

I'm not quite sure what you're getting at here.

I think you're saying that some income-IT's choose not to use one, and will simply manage the issue in a different way, which is fine as that stands, but surely 'income reserve' *means something* to those that do choose to use one?

Having just checked, the AIC website clearly shows that BPET and SLPE both have 'zero' marked in their 'Div. Cover (year)' field.

So that's fine, as it stands, but I still don't see how you get from showing that BPET and SLPE choose to manage the 'dividend-smoothing' aspect of this differently to those that do indeed 'carry' some form of income-reserve, to then saying that it means 'diddly' on it's own...

Surely it means 'something' - it's just that some income-IT's choose not utilise it....?

Cheers,

Itsallaguess

[77ss]

.....

So that's fine, as it stands, but I still don't see how you get from showing that BPET and SLPE choose to manage the 'dividend-smoothing' aspect of this differently to those that do indeed 'carry' some form of income-reserve, to then saying that it means 'diddly' on it's own...

Surely it means 'something' - it's just that some income-IT's choose not utilise it....?

Cheers,

Itsallaguess

Well, 'Surely it means 'something'' - one would like to think so, but can you put your hand on your heart and tell me exactly what it does mean? What this 'something' is? To me, the private investor, rather than to the accountants?

Does the existence of an 'income reserve' per se, really provide an extra safety net - and if so, how? I've seen speculation about borrowing to sustain the dividend but how does having a paper 'income reserve' make that easier or cheaper?

This is a serious question - I've not really thought about this before - and I'm wondering whether I've been casually accepting 'received wisdom'.

[tikunetih]

Prior to 2012, ITs could only pay divis from their revenue reserves (ie. from income they'd received in the current year, or from the accumulated income received in all prior years that had not already been distributed to shareholders).

Following the rule change, IT divis could be paid from both capital and revenue reserves, ie. from profits on asset sales (whether in the current year, or the accumulated profits from prior years' asset sales that hadn't already been distributed) or from income, as previously.

https://www.theaic.co.uk/aic/news/press ... of-capital

My guess is that income-focused ITs (or the industry itself) still like to vaguely promote this revenue reserve as giving them the capacity to do something that other ITs once couldn't do, without really highlighting that following that 2012 rule change it doesn't really amount to anything. That, and the fact the word "reserve" sounds appealing and prudent, when really it's just an accounting term.

I think so long as investors understand what these reserves are (and what they're not), then there's not really a problem. My original post really was just to highlight that the reserves didn't comprise a safe full of cash/gilts waiting to be paid out, but instead simply form part of the invested portfolio, with the reserve being a bookkeeping item without too much relevance except for the people running the IT and doing their accounts.

It seems everyone's roughly on the same page now, so good.

[Itsallaguess]

So that's fine, as it stands, but I still don't see how you get from showing that BPET and SLPE choose to manage the 'dividend-smoothing' aspect of this differently to those that do indeed 'carry' some form of income-reserve, to then saying that it means 'diddly' on it's own...

Surely it means 'something' - it's just that some income-IT's choose not utilise it....?

Well, 'Surely it means 'something'' - one would like to think so, but can you put your hand on your heart and tell me exactly what it does mean?

What this 'something' is?

To me, the private investor, rather than to the accountants?

Does the existence of an 'income reserve' per se, really provide an extra safety net - and if so, how?

I've seen speculation about borrowing to sustain the dividend but how does having a paper 'income reserve' make that easier or cheaper?

This is a serious question - I've not really thought about this before - and I'm wondering whether I've been casually accepting 'received wisdom'.

If we take Merchants Trust as an example, and look at the AIC website, they are currently showing that MRCH has a 'Revenue Reserve' of £28.3m, which equates to a 'Dividend Cover' of 0.91 years -

https://www.theaic.co.uk/aic/find-compa ... set=import

If we then have a look at the last set of full-year Merchants results from 29th March 2019, we can see that under the 'Capital and Reserves'' section, there is an entry for 'Revenue Reserve', with a value of £28,337,693 -



Source - https://www.investegate.co.uk/merchants ... 00054005U/

That is a separate entry under 'Equity Shareholders Funds', although you can see from the above results link that the same sum also exists under the section called 'Net assets at 31 January 2019', under the heading 'Revenue Reserve'.

Is that the sort of answer that you're looking for?

Cheers,

Itsallaguess

[77ss]

So that's fine, as it stands, but I still don't see how you get from showing that BPET and SLPE choose to manage the 'dividend-smoothing' aspect of this differently to those that do indeed 'carry' some form of income-reserve, to then saying that it means 'diddly' on it's own...

Surely it means 'something' - it's just that some income-IT's choose not utilise it....?

Well, 'Surely it means 'something'' - one would like to think so, but can you put your hand on your heart and tell me exactly what it does mean?

What this 'something' is?

To me, the private investor, rather than to the accountants?

Does the existence of an 'income reserve' per se, really provide an extra safety net - and if so, how?

I've seen speculation about borrowing to sustain the dividend but how does having a paper 'income reserve' make that easier or cheaper?

This is a serious question - I've not really thought about this before - and I'm wondering whether I've been casually accepting 'received wisdom'.

If we take Merchants Trust as an example, and look at the AIC website, they are currently showing that MRCH has a 'Revenue Reserve' of £28.3m, which equates to a 'Dividend Cover' of 0.91 years -

https://www.theaic.co.uk/aic/find-compa ... set=import

If we then have a look at the last set of full-year Merchants results from 29th March 2019, we can see that under the 'Capital and Reserves'' section, there is an entry for 'Revenue Reserve', with a value of £28,337,693 -



Source - https://www.investegate.co.uk/merchants ... 00054005U/

That is a separate entry under 'Equity Shareholders Funds', although you can see from the above results link that the same sum also exists under the section called 'Net assets at 31 January 2019', under the heading 'Revenue Reserve'.

Is that the sort of answer that you're looking for?

Cheers,

Itsallaguess

No.

I am perfectly capable of looking at balance sheets and the existence of an item on paper described as 'Revenue Reserves' is totally and utterly irrelevant to my questions. I repeat, in a different way, exactly how does the existence of this item help an IT through hard times?

You stated Surely it means 'something' - what, if anything, does it really mean?

[Itsallaguess]

I repeat, in a different way, exactly how does the existence of this item help an IT through hard times?

Merchants had this to say in their 2017 Annual Financial Report -

Our net earnings were unchanged this year but we have over the years retained substantial reserves to enable shareholders to be provided with a high and growing income.

The final dividend of 6.1p will be paid on 18 May 2017 to shareholders on the register on 21 April 2017. This dividend requires a modest contribution from revenue reserves.

https://www.merchantstrust.co.uk/srp/lit/Xranym/Annual-Financial-Report_The-Merchants-Trust-PLC_31-01-2017.pdf

That seems to show that the existence of the 'Revenue Reserve' helped Merchants to be able to pay some of their own dividend that year.

Cheers,

Itsallaguess

[bluedonkey]

I repeat, in a different way, exactly how does the existence of this item help an IT through hard times?

Merchants had this to say in their 2017 Annual Financial Report -

Our net earnings were unchanged this year but we have over the years retained substantial reserves to enable shareholders to be provided with a high and growing income.

The final dividend of 6.1p will be paid on 18 May 2017 to shareholders on the register on 21 April 2017. This dividend requires a modest contribution from revenue reserves.

https://www.merchantstrust.co.uk/srp/lit/Xranym/Annual-Financial-Report_The-Merchants-Trust-PLC_31-01-2017.pdf

That seems to show that the existence of the 'Revenue Reserve' helped Merchants to be able to pay some of their own dividend that year.

Cheers,

Itsallaguess

Yes exactly. The revenue reserves are the amount of dividends that the IT has received in past years but hasn't paid out. If the dividends coming in fall somewhat, then there's a good chance that the dividend paid out can be maintained as the incoming dividends were larger than the outgoing. If incoming was 100, paid out 85, and then the 100 falls to 90, there's still room to keep paying the 85, etc.

[77ss]

I repeat, in a different way, exactly how does the existence of this item help an IT through hard times?

Merchants had this to say in their 2017 Annual Financial Report -

Our net earnings were unchanged this year but we have over the years retained substantial reserves to enable shareholders to be provided with a high and growing income.

The final dividend of 6.1p will be paid on 18 May 2017 to shareholders on the register on 21 April 2017. This dividend requires a modest contribution from revenue reserves.

https://www.merchantstrust.co.uk/srp/lit/Xranym/Annual-Financial-Report_The-Merchants-Trust-PLC_31-01-2017.pdf

That seems to show that the existence of the 'Revenue Reserve' helped Merchants to be able to pay some of their own dividend that year.

Cheers,

Itsallaguess

It shows nothing of the kind (although I accept that it may be true). Merchants make a statement about the benefits of retaining substantial reserves and you accept it uncritically? Where are these reserves - what do they in actual fact consist of? How are they separated from the rest of the business? Is there a ring-fence? Cash with a bank? Gold? Bonds? Or are they just on paper? Real or chimerical?

I don't suppose we are going to get any further with this, but it's been interesting thinking about it. I shall keep a close eye on how my ITs with zero to low income reserves get on.

[Itsallaguess]

Merchants had this to say in their 2017 Annual Financial Report -

The final dividend of 6.1p will be paid on 18 May 2017 to shareholders on the register on 21 April 2017. This dividend requires a modest contribution from revenue reserves.

https://www.merchantstrust.co.uk/srp/lit/Xranym/Annual-Financial-Report_The-Merchants-Trust-PLC_31-01-2017.pdf

That seems to show that the existence of the 'Revenue Reserve' helped Merchants to be able to pay some of their own dividend that year.

It shows nothing of the kind (although I accept that it may be true).

I'm struggling a little here, so please bear with me.

When you say 'it shows nothing of the kind', I can only really explain how I got to the point of thinking that it did...

Here's my logic -

1. I've said that it 'seems to show that the existence of the 'Revenue Reserve' helped Merchants to be able to pay some of their own dividend that year (2017)'

2. I've said this because they clearly state in their 2017 Annual Financial Report - 'This dividend required a modest contribution from the revenue reserves'.

Can you please highlight the fault-line in my logic that leads you to claim that 'it shows nothing of the kind'?

Are you saying that they are actively lying in their financial report?

When a casual observer might think 'Hey-ho - they've had to dig into their revenue-reserves to pay their dividend this year', which I would suspect might raise at least a few negative thoughts around the sustainability of such dividend payouts, then why would they lie about *that* - why not just lie and say 'the dividend-payouts were covered - nothing to see here - move along please....etc...etc...'?

Cheers,

Itsallaguess

[nmdhqbc]

It seems like the revenue reserves are kept constant in the accounts. While the actual value of the excess revenue that gets invested along with the rest of the portfolio is fluctuating with the market. Is there a reason for this? Seems the % the revenue reserves are of the whole portfolio will increase as the NAV goes down.

Not sure how I feel about it. On one hand I'd not really want 3-5% of my investment being in cash dragging performance. But then when the reserves get used is the worst time for them to be selling depressed assets to use as income. Or adding to gearing without buying more assets.

[tikunetih]

Where are these reserves - what do they in actual fact consist of? How are they separated from the rest of the business? Is there a ring-fence? Cash with a bank? Gold? Bonds? Or are they just on paper? Real or chimerical?

I don't suppose we are going to get any further with this,

If you look back over the previous couple of pages of posts I think you should find that everything you're asking has already been answered. Maybe take another read.

But, again, a (final!) quick summary:
- companies pay divis out of what are called 'distributable reserves';
- for ITs, which are a special type of company, the 'capital reserve' and 'revenue reserve' comprise the distributable reserves;
- 'capital reserve' (accumulated, as-yet undistributed profits from asset sales) and 'revenue reserve' (accumulated, as yet-undistributed income received) are just accounting terms for items appearing on the balance sheet, see up-thread for more explanation of them;
- they are not a description of segregated parts of an IT's underlying investment portfolio;
- the balance sheet (including these reserve entries) is not describing the make-up the IT's underlying investment portfolio.

This latter point may well be the essence of confusion about these 'reserves', with people perhaps making an assumption about what they are and not realising the specific accounting meaning.

If this is still all gobbledegook then don't worry about it!

For the resident accountants, feel free to correct the above - look at the time! I'm out of here