Investment Trust Reserves

[Darka]

This months Shares magazine has a good description of how Investment Trusts manage their reserves, entitled "The great misconception
about investment trust revenue reserves".

It describes how reserves are not piles of cash, but are usually invested in the trust itself.

I know a lot of us are aware of this, but it could be interesting for those new to IT's (I get a free subscription with my YouInvest SIPP).

regards,

[Itsallaguess]

This months Shares magazine has a good description of how Investment Trusts manage their reserves, entitled "The great misconception
about investment trust revenue reserves".

It describes how reserves are not piles of cash, but are usually invested in the trust itself.

I know a lot of us are aware of this, but it could be interesting for those new to IT's (I get a free subscription with my YouInvest SIPP).

And here's a link to the online article itself -

Revenue reserves are often touted as a major advantage of owning investment trusts over traditional funds (also called open-ended funds). However, there can be some misunderstanding over how this feature works, which we will now explain.

Investment trusts (also called closed-ended funds) are allowed put aside up to 15% of their income to support dividend payments during harder times, which is called the revenue reserve. This is one of the factors why many investment trusts have a long track record of rewarding shareholders with consistent dividend growth.

Today’s Covid-19 scorched economic landscape is just the time when this unique feature of investment trusts should come into its own.

https://www.sharesmagazine.co.uk/article/the-great-misconception-about-investment-trust-revenue-reserves

Cheers,

Itsallaguess

[nmdhqbc]

For example, if the net asset value grows at a compound annual growth rate of 8%, the reserves will double in around nine years.

They still can't communicate it clearly. The level of the revenue reserve would not double just because the capital value does. We know what it means but this sentence could and probably will be misinterpreted.

[mc2fool]

For example, if the net asset value grows at a compound annual growth rate of 8%, the reserves will double in around nine years.

They still can't communicate it clearly. The level of the revenue reserve would not double just because the capital value does. We know what it means but this sentence could and probably will be misinterpreted.

To be clear, are you saying that 'cos the revenue reserve is simply a bookkeeping entry, ceteris paribus, it retains its nominal amount and is unaffected by changes in NAV?

So, if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?

[nmdhqbc]

To be clear, are you saying that 'cos the revenue reserve is simply a bookkeeping entry, ceteris paribus, it retains its nominal amount and is unaffected by changes in NAV?

So, if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?

Yep. Unless I'm mistaken?

[mc2fool]

To be clear, are you saying that 'cos the revenue reserve is simply a bookkeeping entry, ceteris paribus, it retains its nominal amount and is unaffected by changes in NAV?

So, if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?

Yep. Unless I'm mistaken?

I've never considered it before, but it sounds right.

[Dod101]

Yep. Unless I'm mistaken?

Yes of course. You are not mistaken because that is the value of the reserve. The Revenue Reserves are not expressed as units; they are expressed as an actual value. The NAV may have increased but that will be reflected in the other capital reserves.

Dod

[Itsallaguess]

For example, if the net asset value grows at a compound annual growth rate of 8%, the reserves will double in around nine years.

They still can't communicate it clearly. The level of the revenue reserve would not double just because the capital value does. We know what it means but this sentence could and probably will be misinterpreted.

To be clear, are you saying that 'cos the revenue reserve is simply a bookkeeping entry, ceteris paribus, it retains its nominal amount and is unaffected by changes in NAV?

So, if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?

Can we tease this one out a little, because I'm struggling to get the detail of it..

If at any given set of results, the revenue-reserve is stated to be £10m, for example, and it's currently invested in 10,000 shares in Dinglebat.Com within the trust, and at the next set of results, if the share-price of Dinglebat.com has gone up 10% since the previous year, would we expect the revenue-reserve to still be stated (all other things being equal..) as £10m, or would they be right to now re-state it the revenue-reserve at £11m, given that the underlying 'revenue reserve holdings' had gone up in value by 10%?

Or would that additional 10% uplift in the value of Dinglebat.com get tracked in the 'non-revenue-reserve' NAV?

I think I'm struggling to align the fact that the revenue-reserves are part of the NAV, but it seems from the posts on this thread that they wouldn't 'benefit' from any up-lift in the actual holdings...is that right?

Overall, I don't suppose it would matter if it is, as we'd perhaps often expect additional revenue-reserves to be added over the year anyway, but Dod's statement about the lack of 'unit-value statement' with regards to the revenue-reserve seems to agree with the above, and it's not something I'd considered until this thread has mentioned it.

Cheers,

Itsallaguess

[LittleDorrit]

For any accounting period:-

Nett revenue return after taxation (Income Statement)
-Dividends paid (Cashflow)
=Change in revenue reserve (Balance Sheet)

As a non accountant I'm sure that I used to find the old fashioned IT accounts quicker to read.

[Alaric]

If at any given set of results, the revenue-reserve is stated to be £10m, for example, and it's currently invested in 10,000 shares in Dinglebat.Com within the trust

It isn't though, there's no more hypothecation than to observe that the total NAV is £ 100 m of which the Capital Reserve is £ 90 m and the Revenue Reserve £ 10 m.

If an individual ran their affairs in a manner similar to an Investment Trust, then for every £ 100 of dividend, they might draw £ 85 and reinvest £ 15, but without keeping long term track of where the £ 15 had been reinvested.

[EthicsGradient]

The reserve may not be specifically invested in dinglebat.com, but surely the point is that it is invested in the overall assets of the trust, rather than being in cash, which would mean that the answer to

"if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?"

should actually be "no. It will be £20m".

[Itsallaguess]

The reserve may not be specifically invested in dinglebat.com, but surely the point is that it is invested in the overall assets of the trust, rather than being in cash, which would mean that the answer to

"if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?"

should actually be "no. It will be £20m".

And it was this confusion that has led to me asking which one it is...

Your answer of 'no, it will be £20m', would align with the section of the article previous to the one quoted earlier in this thread by nmdhqbc.

That previous line in the article says this -

The undistributed cash is invested in the trust’s assets and therefore the reserves benefit from the growth of the assets.

https://www.sharesmagazine.co.uk/article/the-great-misconception-about-investment-trust-revenue-reserves

So the article seems to be clear that any appreciation in the underlying 'revenue reserve' assets would be reflected in the reserves themselves, whilst some here seem to think that this wouldn't be the case?

Cheers,

Itsallaguess

[Dod101]

IAAG. With respect you need a crash course in IT accounts. The point is that the Revenue Reserve is simply a figure derived solely from the net surplus of revenue earned over the time since the Reserve was established. Any change in the NAV (that is the aggregate value of the assets (meaning investments)) are dealt with through a separate account called Realised/Unrealised Capital Gains and it is to that Reserve that all increases or decreases in the NAV is credited, not to the Revenue Reserve. The distinction used to be much more important than it is these days because only the revenue reserves were distributable, that is can be used for dividends. The Revenue Reserve as we know is the net accumulation of gains and losses from the Revenue, but on the asset side it is usually just a big pot where the assets are fungible, a word beloved by some of us, and so long as the sum of the assets is equal to the sum of the liabilities, that is share capital, Realised/Unrealised gains, and the Revenue Reserve, all is well. The point though is that all gains and losses of the assets are charged to the Unrealised/Realised Reserve, the Revenue Reserve being unchanged except as a result of a credit or debit from the Revenue Account.

As I said, the RR is not represented by units it is represented by actual value and just to repeat, it will not be individually invested but is just part of the total investmenst held.

Dod

[Alaric]

So the article seems to be clear that any appreciation in the underlying 'revenue reserve' assets would be reflected in the reserves themselves, whilst some here seem to think that this wouldn't be the case?

As far as I am aware there isn't an accounting process that revalues the Revenue Reserve. It would however be correct to note that if the Revenue Reserve had been held as segregated cash, then it would not benefit from the growth in net assets.

[Dod101]

The reserve may not be specifically invested in dinglebat.com, but surely the point is that it is invested in the overall assets of the trust, rather than being in cash, which would mean that the answer to

"if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?"

should actually be "no. It will be £20m".

Pardon? I am not sure where EthicsGradient has got that but that is the heart of the confusion. The RR would still be only £10 million (except of course in the ten intervening years, it will probably have been added and subtracted to by undistributed surpluses or deficit in the amount of revenue paid as a dividend each year). All of any capital surplus goes to the capital reserves, not to the revenue Reserves.

Dod

[LittleDorrit]

The confusion arises because the article bandies about the word reserves without thought or discipline.
It should seperately and specificaly refer to total reserves, revenue reserves and capital reserves.

I can only sugest that contributers look at the balance sheet statement of a trust that they hold.

[Dod101]

For example, if the net asset value grows at a compound annual growth rate of 8%, the reserves will double in around nine years.

They still can't communicate it clearly. The level of the revenue reserve would not double just because the capital value does. We know what it means but this sentence could and probably will be misinterpreted.

To be clear, are you saying that 'cos the revenue reserve is simply a bookkeeping entry, ceteris paribus, it retains its nominal amount and is unaffected by changes in NAV?

So, if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?

Despite other comments yes that is exactly the point and the article should have qualified its comment on reserves by the word 'capital' in front of reserves.

Dod

[nmdhqbc]

The reserve may not be specifically invested in dinglebat.com, but surely the point is that it is invested in the overall assets of the trust, rather than being in cash, which would mean that the answer to

"if the NAV is, say, £100m of which £10m is deemed revenue reserve, and ten years later the IT has grown to a NAV of £200m then the revenue reserve (if nothing had been added or taken out of it) would still be on the books as £10m, yes?"

should actually be "no. It will be £20m".

2 different things here. £20m would be the amount the revenue held back is now worth*. But "Revenue Reserves" has a specific definition and implications and that is not it. Only £10m would be distributable in bad times. Of course being able to pay dividends out of capital makes all this moot anyway to a certain extent.

* Although actually a lot of that £10m would have been build up in previous years where dinglebat.com would have had a different valuations again. So the starting point of £10m would probably different looking at it in these terms.

[scotia]

Is an IT constrained to only providing a dividend from income and from revenue reserves?
Or can it also enhance its dividend from the sale of investments - whether or not they are associated with gains or income.
If the latter, then a revenue reserve is clearly an irrelevance.

[Itsallaguess]

The point is that the Revenue Reserve is simply a figure derived solely from the net surplus of revenue earned over the time since the Reserve was established.

Any change in the NAV (that is the aggregate value of the assets (meaning investments)) are dealt with through a separate account called Realised/Unrealised Capital Gains and it is to that Reserve that all increases or decreases in the NAV is credited, not to the Revenue Reserve.

Thanks Dod, so with respect to this section of the linked article, and specifically regarding the final line of information shown -



https://www.sharesmagazine.co.uk/articl ... e-reserves

Given that the whole article is about 'revenue reserves', I can only conclude that the final line's use of the words 'the reserves benefit' is related to the revenue reserves, but you and others seem to be saying that such a statement would be false.

I'm not trying to suggest what is or isn't correct here, by the way - I'm simply trying to discover why an article purporting to dispel 'The great misconception about investment trust revenue reserves' might then go on to actually introduce one itself...

Cheers,

Itsallaguess