When is a dividend not a dividend? When it is paid out by an increasingly number of investment trusts.
This week, Scottish Mortgage one of the trusts we hold in our investment trust portfolio announced that the income from the companies in which it invests is not high enough to cover the dividend it intends to pay out this year. So the dividend will be paid out of its revenue reserve (the saved-up income from past years). Next year, things will be worse: there probably won't be enough left in the reserve to pay the dividend. So the directors have said they will pay the dividend out of capital.
This is entirely above board (investment trusts were given the right to do it last year). But in the past I haven't been too keen on it as an idea: capital and income are taxed in different ways and it isn't up to the directors of a trust to decide on behalf of investors which is which. If there isn't the income to pay a dividend, and investors still want to withdraw money from a fund, they can surely make their own decision to do so and sell some of their shares on which they may or may not pay capital gains.
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As far as I can see the very idea of doing it for them was yet another horrible manifestation of the perverse effects of super low rates: if everyone wants income, the financial industry will find a way of giving it to them or at least pretending to give it to them.
However, I am now beginning to see how investment trusts might start to use their ability to play around with capital/income definitions to work for a new class of investors pension freedomers.
This lot have a set lump sum they have to make work for them over a 20-30 year period. Most of them won't be able to survive on the income alone: they will have to use the capital too. And how can they make sure that they use the capital carefully and gradually? Via a fund that promises to give them an income of, say, 3% every year in whatever balance of capital and income that works (as annuities used to, albeit while taking all of your capital hostage).
I don't think that this is what Scottish Mortgage is explicitly trying to do it isn't the kind of fund most people suggest for pensioners. But other funds of its size with a more diversified brief might like to think about it.
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