Investment companies offer a unique combination of features that can make them very attractive to income seekers.
Many open-ended funds are restricted to investing in certain types of shares and securities. Investment companies have no such restrictions and can invest in a wide range of other investments that can generate a higher income. Assets like commercial property, infrastructure and renewable energy can all offer a higher level of income and, being illiquid, are better suited to being held in a closed-ended fund like an investment company.
Many open-ended funds are required to pay out all their income each year. Investment companies can hold back some income in good times to pay it out in leaner ones. This means that investment companies can maintain or increase their dividends even at times when the companies they invest in are reducing theirs.
Investment companies, unlike open-ended funds, can borrow money to purchase additional investments (‘gearing’). If this is invested in assets which produce income, this can help to boost the dividends you receive. Gearing increases the risks to income and capital. However, not all investment companies use gearing, and most only use modest levels.
Investment companies, unlike many open-ended funds, don’t have to pay dividends just out of the income they receive from investments. They can also use the profits they make when they buy and sell investments.
As this flexibility will reduce the capital profits you might make, it tends to be used quite sparingly. However, it can be a useful tool to maintain or increase dividends in more difficult times.
Want to know the difference between an open-ended and closed-ended fund? See the Glossary on the AIC website.