IT dividend rule 'could hit shareholders in the pocket'

Fund management groups and analysts have warned new dividend rules for investment trusts could see shareholders lose out as portfolios become less tax efficient.

Under the new rules set out in the Finance Bill at the start of this year and set to come into force in April, UK-domiciled investment trusts will be able to pay out capital gains as income.

This will grant investment managers a higher degree of flexibility, but fund management heads have warned the rule change has a number of drawbacks.

James de Sausmarez, head of investment trusts at Henderson Global Investors, opposes the new regulations as he said they are inefficient from a tax point of view.

Sausmarez said private client shareholders will be hit hard in the pocket if capital gains are redistributed into income. “With capital gains taxed at 28% and the higher rate taxpayers stumping up 50% for income, distributing capital gains will be very tax inefficient,” he said.

“Investment trust shareholder registers are, on the whole, made up of private client investors, and I do not think they will thank the fund management groups who are giving up their capital gains.

“Investors want to see a preservation of capital and a decent yield as opposed to having their capital eroded.” 

Charles Cade, investment trust analyst at Numis Securities, added total return should be more important to trust managers than income. “While we are in favour of greater flexibility in the treatment of capital and income returns, we believe the primary focus should be total returns,” said Cade.

“Yield investors are seeking a predictable, sustainable income, in our view, and we do not believe a commitment to pay a dividend only in years when there are capital gains is appealing.”

However, Andrew Watkins, sales director of specialist funds at Invesco Perpetual, said the revised rules will be especially beneficial to the newer investment trusts in the market.

He said older trusts in the sector, such as Neil Woodford’s £930m Edinburgh investment trust, and the £120m Invesco Income Growth trust, have been able to build revenue reserves to enhance income.    

“I think at first the rule change will not have a huge impact on the larger and older trusts in the sector because they have been around long enough to build up their revenue reserves,” he said.

“However, for the new companies and the trusts that have little left in the tank in terms of dividend reserves, it is a great advantage for them.”

Watkins added the portfolio composition of Invesco Perpetual’s two closed-ended UK equity income trusts will not change as a result of the shakeup.

One of the younger vehicles in the sector aiming to take advantage of the rule change is the £50m Diverse Income trust which launched last year, run by MAM Funds’ Gervais Williams.

Williams supports the rule change as he said it will level the playing field between OEICs and their closed-ended peers, and will allow managers to hold a wider variety of stocks to fulfill their income requirements.

However, he warned investment managers could be caught out if they rely too heavily on capital gains. “Income managers will now not necessarily be forced to own the big blue-chip income payers, and instead can generate dividends from other stocks which focus on capital growth,” said Williams.

“But with the increased flexibility comes the danger the fund manager could produce poor returns if they rely upon the capital gains and have a bad couple of years performance wise, or the market has a mediocre year.”