ISA Insights: Maximising income and growth, today and tomorrow
Budget 2017 inadvertently demonstrated
the value of making use of Individual Savings Account (ISA) annual allowances every year to shelter as much of your savings from tax as possible.
Less than 12 months earlier, a £5,000 dividend allowance had been introduced in April, 2016, allowing shareholders to receive that much income from their investments tax-free.
As a result, some shareholders may have thought they had no need of the ISA tax shelter but Chancellor Philip Hammond announced in March, 2017, that the dividend allowance will be cut by 60% with effect from April, 2018.
After that, investors receiving more than £2,000 annual dividends will be liable to tax but ISAs can continue to pay unlimited income with no further tax liability – showing why it pays to squirrel away as much as possible in this tax shelter.
How to obtain income today when interest rates are near historic lows
Income is a priority for many investors while interest rates remain at or near historic lows.
Yield – or the income paid by an asset, expressed as a percentage of its purchase price – has also been depressed in many cases by low interest rates.
However, we believe it may be dangerous for stock market investors to ‘chase yield’ – or buy shares offering high dividends – as these income payments can be cancelled or cut without warning. A high yield can be a sign that the market expects dividends to be cut or cancelled or some other form of trouble to come.
‘Income is a priority for many investors while interest rates remain at or near historic lows’
Investment trusts enjoy a unique advantage over other forms of pooled funds – which aim to diminish the risk of stock markets by diversification – because they can enhance dividend payments to their shareholders. Investment trusts can do this by supplementing income from their underlying portfolios of assets with capital gains realised by selling some of those assets at a profit. This facility is variously known as enhanced dividends, enhanced income or enhanced yield. To note, diversification does not guarantee investment returns and does not eliminate the risk of loss
Income and growth or a mixture of both
Investment returns come in two forms; capital gains, generated by increases in the price of an asset, and income payments – such as dividends.
This fact is reflected by HM Revenue & Customs imposing two different levies – primarily income tax and capital gains tax. There are also two different sets of annual allowances, or amounts of income and capital gains that can be received each year before tax must be paid.
Similarly, many different types of investment trust seek different forms of return – as often indicated by the word ‘income’ or ‘growth’ in their title.
Some, such as JPMorgan Global Growth & Income plc aim for a mixture of both. Whether you are an experienced investor or an absolute beginner, J.P. Morgan Asset Management’s website is a good place to start considering which – if any – might suit you. Whether you are building up a nest egg or considering using new freedoms to do what you like with your pension this website may help you identify financial solutions that meet your needs.
Since 2012 investment trusts have been allowed to enhance or increase dividends or the income they pay to their shareholders by realising gains on some of these pooled funds’ underlying portfolios of assets.
This can make these trusts more attractive to investors whose priority is income – for example, people who must live off their savings to some degree, such as pensioners using income drawdown.
‘can make these trusts more attractive to investors whose priority is income’
Some other people who have no immediate need for an income from their investments also place a high priority on what is sometimes called the ‘discipline of dividend investing’ because dreams of capital gains can prove illusory but dividend income payments are a regular and tangible test of failure or success. They either turn up on time or they don’t.
With interest rates at or near historic lows and many bank or building society accounts failing to pay sufficient interest to match the rate at which inflation is eroding the real value or purchasing power of money, income is a priority for many investors.
However, shares in some geographical sectors – such as Asia – do not have the same history as UK shares of paying substantial dividends or offering an attractive yield.
The enhanced income facility introduced last year at JPMorgan Asian Investment Trust plc enables an enhanced dividend to be paid, at the discretion of this trust’s independent board of directors, while the fund managers can continue to seek to maximise total returns from a sector where these have traditionally come from capital gains.
Discounts and a decent dividend
Enhanced dividends can prove attractive, increasing the volume of buyers of an investment trust and decreasing its discount – or the difference between the share price of many investment trusts and their net asset value (NAV); or the total value of their underlying portfolios of other companies’ shares.
For example, independent research by the stockbroker Winterflood Securities found that after JPMorgan Asian Investment Trust plc and JPMorgan Global Growth & Income plc investment trusts introduced enhanced dividend policies last year, both trusts’ discounts narrowed significantly*. In the case of the latter fund, the discount halved. All other things being equal, this trend should increase the return to shareholders.
Another potential advantage of enhanced dividends is that it can reduce the risk that managers will likely ‘chase yield’ or buy assets that offer to pay substantial income but where total returns may be low or even negative. Such assets are sometimes known as ‘value traps’ where the price of high income today is capital erosion or loss tomorrow.
However, it is important to understand that enhanced dividend policies are not a panacea and could accelerate a decline in NAV when prices are falling.
Important safeguards, checks and balances
One risk of an investment trust selling some of its underlying assets to generate gains in order to enhance dividend payments to its shareholders is that it might end up ‘eating next year’s seed corn’.
Shares that are sold to boost dividends today cannot generate any returns to the existing holder in future. That is why important safeguards have been put in place to reduce the risk of enhanced dividend policies creating unintended effects.
‘to ensure that enhanced income payouts do not reduce total returns’
For example, the independent board of directors at JPMorgan Asian Investment Trust plc review their enhanced dividend policy every three months to ensure it remains in the best interests of all this trust’s shareholders.
Similarly, JPMorgan Global Growth & Income plc’s independent board of directors review this trust’s enhanced dividend policy once a year. The intention in both cases is to ensure that enhanced income payouts do not reduce total returns but deliver these to shareholders in the most effective way, increasing the attractiveness of these trusts and improving the prices at which they trade on the stock market.
Maximizing income and growth, today and tomorrow
Enhanced dividend policies can potentially enable investment trusts to meet many investors’ need for income today while balancing this with other shareholders’ requirement for growth tomorrow.
They can do so by realising capital gains, by selling some of the assets in their underlying portfolios at a profit, to supplement dividend distributions to shareholders without the need for fund managers to ‘chase yield’ or take unnecessary risks.
However, it is important to understand that enhanced dividends are not a panacea. There is a risk that the price of higher income today might be lower total returns tomorrow.
If too much income is taken by realising gains, there is a risk of investors ‘eating their seed corn’. This is why investment trusts’ independent boards of directors regularly review whether enhanced dividend policies remain in the best interests of all shareholders.
Investors should remember that share prices can fall without warning and that you may get back less than you invest. However, investment trusts seek to diminish the risk inherent in stock markets by diversification and professional fund management.
To note of course Diversification does not guarantee investment returns and does not eliminate the risk of loss. There are hundreds of investment trusts to choose from. For more details see the Association of Investment Companies (http://www.theaic.co.uk/
*Source: Winterfloods Annual Report 2017
This is a promotional document and as such the views contained herein are not to be taken as an advice or recommendation to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you.
It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products(s) or underlying overseas investments. Both past performance and yield are may not be a reliable indicator guide to current and future results performance. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products,(s), there can be no assurance that those objectives will be met.
Investment is subject to documentation (Investor Disclosure Document Investment Trust Profiles, Key Features and Terms and Conditions), copies of which can be obtained free of charge from JPMorgan Asset Management Marketing Limited. Issued by JPMorgan Asset Management Marketing Limited which is authorized and regulated in the UK by the Financial Conduct Authority. Registered in England No: 288553. Registered address: 25 Bank St, Canary Wharf, London E14 5JP 4d03c02a800466cf
*Source: Winterfloods Annual Report 2017