Does the City of London Investment Trust offer dividend potential?

The City of London Investment Trust (LON: CTY) dividend yield of 4.8% should appeal to a wide range of income investors right now.

After all, interest rates are at historic lows. They are not expected to rise in at least 2.5 years and even move into negative territory in the meantime if the post-Covid economic recovery faltered.

In addition, soaring inflation, most recently its highest level in three years, has made real returns on assets like cash and fixed income securities even less attractive. And since the FTSE 100 and FTSE 250 have a dividend yield of 3% and 1.9% respectively, the trust offers a relatively attractive return.

Global dividend growth

Of course, the City of London Investment Trust’s high returns are not surprising. It is an income-driven company that aims to grow dividends and capital over the long term. It has a long track record in that regard, with dividends per share rising at an annualized rate of around 5% over the past 20 years.

The City of London Investment Trust currently trades at a 2% premium on its net asset value (NAV). Its running fees (OCF) of 0.36% are similar to many of its competitors.

The trust’s geographic focus, however, is on the UK, with around 88% of its holdings in the UK in listed companies. However, a look at its largest holdings reveals that it generates much of its revenue from around the world.

The top ten portfolios include popular global income stocks like British American Tobacco, Shell and HSBC. However, there are stocks that can generate dividend growth as well, including Diageo, Unilever and M&G. As a result, the prospect for the trust’s post-inflation dividend distributions appears relatively bright.

Risk / Reward Considerations

The City of London Investment Trust’s top ten holdings account for 29% of its total assets. Its 83 holdings in total indicate that it offers a diversified portfolio, which is reflected in its relatively low volatility over the past few years. In fact, it is a top quartile performer among its peer group based on volatility over the past three years.

In assessing the risk / reward balance of the trust, it has been more difficult to win awards. Even taking into account its low volatility, the trust has delivered a Sharpe ratio in the third quartile for the past three years.

This is due to the underperformance of the Investment Trust UK Equity Income Benchmark. With a total return of 29% versus 45% for the benchmark, it has achieved third quartile performance over the past five years.

A major reason for this could be the unpopularity of many of its key holdings at a time when investors have moved from value to growth stocks with growing hopes for an economic recovery. In fact, the stock price has outperformed the benchmark by 17% on a cumulative basis over the past decade, with a total return of 101% versus 84% ​​for the benchmark.

Long term attraction

Hence, the City of London Investment Trust’s long-standing track record of capital appreciation and dividend growth coupled with low volatility can sufficiently offset its recent underperformance to earn income investor interest. It could appeal to a wide range of dividend-seeking investors looking to weather persistently low interest rates and rising inflation over the long term.

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