How to earn a dividend yield above 5% by backing Britain

UK funds may have underperformed their peers when it comes to growth recently but income-hungry investors can still benefit from an inflation-beating dividend yield through investment trusts.

Investment trusts are popular among private investors,

High interest rates may have boosted the allure of bonds for income but research by AJ Bell - based on the Association of Investment Companies (AIC) latest dividend heroes list - has revealed five UK equity income-focused investment trusts that currently have a dividend yield above 5%.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

It comes as chancellor Jeremy Hunt wants to boost investment in Britain and is planning to launch a British ISA.

Investors don’t have to wait though as investments held in a stocks and shares ISA are sheltered from any dividend tax that would be owed on the income payments.

The UK equity income investment trusts paying above 5%

High interest rates may have benefited cash savers and bond investors with returns above the rate of inflation.

But investors looking to invest in the UK through investment trusts can also benefit from decent dividend yields.

Research by investment platform AJ Bell has uncovered five UK equity income trusts with a yield above 5%.

The highest, Abrdn Equity Income, currently pays a yield of 8.4%, while taken together the average across all five would be 5.8%.

That compares to the best variable Cash ISA yielding 5.11% and the best fixed term cash ISA yielding 5.25%, according to Moneyfacts.

The long-term performance of the UK equity income investment trusts is also attractive.

On a five-year basis, the JP Morgan Claverhouse investment trust has grown its dividend by 4.6% annually. 

While the yield is not guaranteed, unlike with a fixed savings rate or bond, Laith Khalaf, head of investment analysis at AJ Bell, says these investment trusts have increased their dividend each year for at least 23 years and for an average of 40 years.

For example, City of London investment trust has an unbroken dividend record stretching back to 1966, the year in which England won the football World Cup and number one records in the UK included songs from the Beatles, the Kinks and Elvis Presley.

Based on the historic dividend growth achieved by these trusts, after 10 years they could be yielding 8% on an investment made today, Khalaf suggests.

“It’s not just cash savers and bond investors who are enjoying income yields above the rate of inflation, so are those buying investment trusts with exceptionally long records of increasing dividends,” says Khalaf.

“Of course, unlike cash, capital and income is not guaranteed when holding shares. However these trusts have increased their dividend each year for at least 23 years, through the dotcom crash, the global financial crisis, and the Covid pandemic.”

It is also worth considering the discounts on offer and whether you think they are likely to reduce and represent fair value or if there are underlying issues with the investment trusts.

The average discount across the investment trusts is 5.5%, with Schroder Income Growth trading at a 10.8% discount to net asset value.

“There’s no guarantee of a rising income going forward, but the resilience shown by these dividend heroes over such a long time should provide investors with some comfort,” adds Khalaf.

“Investment trusts can hold back income in the bad years to pay out dividends in the good years, a mechanism which has allowed some to continually raise their dividends for decades.

"This doesn’t increase the overall dividend yield produced by the underlying portfolio of shares, but it does offer investors a smoother ride, something which is especially prized by those relying on their investment portfolio to deliver a retirement income.”

Dividend heroes 

There are plenty of investment trusts that pay reliable yields beyond the UK.

The AIC's latest dividend heroes research, which highlights 20 investment trusts that have consistently increased their annual dividends for at least 20 years in a row, shows half now have a 50-year track record.

City of London Investment Trust, Bankers Investment Trust and Alliance Trust now have 57 years of dividend rises, followed by Caledonia Investments at  56 years.

The Global Smaller Companies Trust and F&C Investment Trust have a 53 year track record, while Brunner Investment Trust and JPMorgan Claverhouse are at 52 and 51 years respectively.

The most recent additions to the half-century club are Murray Income Trust and Scottish American at 50 years.

"Despite a tricky few years for the dividend heroes, ten investment trusts now have at least half a century of consecutive annual dividend increases," says Annabel Brodie-Smith, communications director at the AIC.

"They have continued to raise their payouts through the high inflation of the 1970s, recession of the 1990s, the global financial crisis in 2008 and the pandemic – showing their remarkable resilience."

Brodie-Smith says Investment trusts have strong track records of dividend growth because they can hold back up to 15% of the income they receive each year.

"This allows them to hold more income in reserve when times are good to pay out in leaner years, providing a smoother flow of dividends to investors," she says.

"Whilst dividends are never guaranteed, investment trusts’ dividend track records demonstrate their durability.”