This large-cap trust’s 40 years of uninterrupted dividend growth highlights its income appeal

One of the most difficult aspects of investing is maintaining a long-term focus. It is particularly challenging to think many years ahead when the short-term prospects for the stock market are highly uncertain.

Indeed, today’s banking sector woes and downbeat economic growth forecasts are likely to prompt many investors to worry about the here and now rather than the future.

Short-termism, though, can be extremely unhelpful to long-term investment success. For example, an investor who requires a regular income from their portfolio may presently determine that a fixed-rate savings account is preferential to an equity income investment trust such as Merchants.

After all, recent interest rate rises mean the difference in income return between them is paper thin. And with a weak short-term economic outlook, dividend growth in the coming months may be rather limited.

However, over a multi-year time horizon, income-focused investment trusts offer the prospect of dividend growth and capital returns. A fixed-rate savings account offers zero scope for income growth or capital gains.

This column first advised readers to buy Merchants, which focuses on UK-listed large-cap income shares, in February 2020. Even after a pandemic-induced stock market crash and the current period of investor doom and gloom, it has posted an 11pc capital return since our recommendation. Over the past five years it is up 67pc, which trounces the 29pc return of the FTSE All-Share, which is its benchmark.

Perhaps more importantly, the trust has raised dividends per share in each of the past 40 years. During that time, dividends per share have grown from 2.1p to 27.3p. This is an annualised growth rate of 6.6pc, which, while behind today’s inflation rate of 10.4pc, is more than twice the 2.9pc average inflation rate of the past 40 years.

With inflation forecast to fall to within touching distance of the Bank of England’s 2pc target by early next year, the trust’s dividend growth rate is likely to remain ahead of inflation over the coming years. As a result, its 4.9pc yield, which is very similar to the interest rate on a fixed-term savings account, has relatively high appeal for income-seeking investors.

Of course, generating a high and growing income is at the heart of the trust’s strategy. It aims to buy sound companies when they trade at fair prices. This means it seeks to avoid high-yielding stocks that lack solid balance sheets or a clear competitive advantage, and is comfortable missing out on highly rated growth shares that are devoid of a margin of safety.

In Questor’s view, such an approach is entirely sensible for investors seeking a reliable, inflation-beating income return combined with capital growth over the long run.

Around 60pc of the trust’s holdings are large-cap shares, with well-known names such as Shell, GSK, Rio Tinto and SSE among its largest positions. While it has started to invest in international stocks, its focus on FTSE 100 companies means it is already more reliant on the global, rather than UK, economy owing to the index’s international bias.

Although the company trades at a modest 1pc premium to net asset value in an era where many investment trusts offer sizeable discounts, its current premium is in line with its 12-month average. And while gearing of 7pc has been unhelpful of late as the FTSE 100 has spiralled downwards, it will magnify returns in a rising market.

When that will commence is clearly a known unknown. In the meantime, it would be unsurprising for the trust to experience elevated levels of share price volatility as the full effect of rapidly rising interest rates on consumers, companies and, significantly, the banking sector becomes clear.

Alongside the prospect of slowing dividend growth, this could naturally dissuade some income investors from purchasing the trust at a time when they can obtain a 4pc plus interest rate on their cash savings.

However, in Questor’s view, it is imperative to look beyond current news and short-term forecasts to plan for the long term. The vast majority of investors have an extended time horizon, which means their income must grow by at least as much as inflation to maintain their current standard of living.

With Merchants having a stunning track record of dividend growth over recent decades, plus an excellent history of capital returns, it offers a long-term solution to a long-term problem. Buy.

Questor says: buy

Ticker: MRCH

Share price at close: 563p

Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

Read Questor’s rules of investment before you follow our tips