Adapting to a changing UK market

Dunedin Income Growth Investment Trust (DIGIT) may have been around since 1873, but it has always sought to move with the times. Over the years, the trust has adopted an income growth mandate, improved its sustainability footprint and shifted its investment parameters as it has sought to remain a relevant and differentiated investment option. Today, it is adapting to another shift in the UK market.

The UK market is full of exciting, high growth companies, but there has been a persistent problem for income investors: high dividend yields being concentrated in a handful of large companies. The latest Computershare Dividend Monitor showed 36% of UK dividend distributions are paid by just five companies and 62% by the top 15.

Overwhelmingly, these large dividend payers are concentrated in relatively mature, low growth sectors, such as oil and gas, mining or tobacco. These companies may have their place in a portfolio, but they are not likely to provide the long-term dividend growth we want to be able to offer our shareholders in Dunedin Income Growth.

Aggregate dividend growth for the UK market has been anaemic. In 2024, the underlying growth of UK dividends rose by just 2.3% compared to 2023. This was boosted by one-off special payments - on an underlying basis, the total dividend distribution was down 0.4% year on year. The total level of regular and special dividends distributed by UK companies has remained broadly flat over the last ten years. Expectations are for 0-2% growth in UK dividends in 2025.

Increasingly, companies are favouring buybacks over dividends as a way to reward shareholders. The net buyback yield on the FTSE All-Share Index at the end of 2024 was almost 2%, having been close to zero in 2014. Share buybacks in the UK market have grown to around 40% of all shareholder distributions. There are sound reasons for this shift: buybacks can be earnings accretive and support share prices, particularly at a time when the valuation of the UK market is at historic lows. However, it makes it more difficult for trusts like ours to grow payouts to shareholders from dividends alone.

Why are companies doing this? There has been a realisation that paying large, fixed dividends is not necessarily a sensible way to run a business. Overdistribution can constrain a company’s management team if it wants to make significant organic or inorganic investments which may be a more lucrative form of value creation for shareholders. This has been a problem for UK plc more widely and may explain the relative scarcity of blockbuster growth companies compared with other markets.

Changing the dividend strategy

DIGIT is a modern, forward-looking investment trust. Our chairman, Howard Williams, has been at the forefront of previous innovations in the sector, including successful changes to the JP Morgan Global Growth & Income fund. With this in mind, the company has taken the decision to use capital and income reserves to significantly increase dividend distributions to shareholders. The trust will now pay a total dividend of at least 19.1p per share for the year ending 31 January 2026, representing an increase of 34.5% compared to the previous year. This is equivalent to a notional dividend yield of 6% on the current net asset value and a share price dividend yield of 6.5%. By funding the dividend cost from a combination of revenue and capital generation the trust is using one of the key benefits of the investment trust structure.

Broader appeal

A higher yield should make the shares more attractive to a wider audience. As interest rates have risen, we recognise we need to do more to compete with cash savings products. A 6% dividend yield on NAV offers an attractive yield, particularly set alongside a portfolio positioned to deliver total shareholder returns through a quality and growth investing approach. It positions us ahead of our competitors in a sector that is dominated by value style- portfolios.

From here, the aim is to grow the payout progressively. We know a growing dividend is important to many of our shareholders as they look for their investment income to keep pace with cost-of-living increases. The Association of Investment Companies classifies the company as a ‘Next Generation’ Dividend Hero - one of the 30 investment trusts that have raised their dividend for between 10 and 19 consecutive years. We want to maintain this status over the long-term.

This change does not involve any significant shift in the investment philosophy of the trust. However, it does provide greater flexibility. At the moment, we hold around 70% of the portfolio in high quality companies that can compound their growth over time. These are companies such as RELX, London Stock Exchange Group or Sage, which have attractive markets, boast strong financials, and enjoy durable competitive moats. These companies tend to have superior dividend growth because of their robust earnings power.

However, because their dividend yields tend to sit below the market average, it has been important to hold higher yielding companies alongside them. These are companies such as TotalEnergies, M&G, Chesnara, and Taylor Wimpey, with above-market yields. These are good businesses but tend to operate in more cyclical areas and offer lower dividend growth. The new strategy should ultimately allow us to hold fewer of these high yielding companies and focus more on the higher growth ‘quality compounding’ areas. The end result should be an improvement in the quality and expected total return potential of the portfolio.

Despite the significant increase in the dividend, the change should also offer more security to the distribution. Historically dividend payments were supported by income revenues and income reserves, but by also utilising annual capital gains the Trust gains an important additional source of dividend cover. It also will have access, if needed to the very substantial capital reserves which the Trust retains, equivalent to around 12 years of dividend payments at the current rate. Given that the average income trust references revenue reserves equivalent to around one of year of dividend cover, this gives an extraordinary level of underpin to the dividend policy.

In conclusion, the rationale for this decision has become increasingly compelling over the past couple of years. It gives the opportunity to significantly increase the dividend to shareholders, enhance flexibility for the investment managers to potentially enhance total returns and at the same time offer even more security to future distributions. In the long-term, we believe this is a strategy that many similar trusts will adopt. It is forward-looking, reflecting the realities of investing in the UK market today and making the investment trust structure work best for shareholders.

Important information

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The details contained here are for information purposes only and should not be considered as an offer, investment recommendation, or solicitation to deal in any investments or funds and does not constitute investment research, investment recommendation or investment advice in any jurisdiction. Any data contained herein which is attributed to a third party ("Third Party Data") is the property of (a) third party supplier(s) (the “Owner”) and is licensed for use with Aberdeen. Third Party Data may not be copied or distributed. Third Party Data is provided “as is” and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner, Aberdeen, or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates.

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.

The Dunedin Income Growth Investment Trust Key Information Document can be obtained here.

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