Mining stocks caused double trouble for City of London (CTY ) in the second half of last year, but the small hit to earnings doesn’t threaten the £2bn UK equity income trust’s ‘dividend hero’ status. 

Recent half-year results show an underweight position in miners weighed on returns and dividend cuts did knock the trust’s income.

In the six months to 31 December, City lagged its FTSE All-Share benchmark, with a total underlying investment return of 4.5% versus a 5.1% rise in the index.

Chair Laurie Magnus said the ‘underweight in mining [was] the largest sector detractor, and not owning Glencore (GLEN), the mining company, the biggest stock detractor’.

At the end of the year, City held 7% of its assets in the materials sector where miners are classified, 5% less than the All-Share. That was a disadvantage as miners were buoyed by expectations of a surge in demand from the reopening Chinese economy.

Mining stocks also weighed on income, with earnings per share falling 1.7% from 8.94p a year ago to 8.79p as City-owned Rio Tinto (RIO), Anglo American (AAL) and BHP (BHP) all cut dividends in response to falls in the price of commodities such as iron ore.

Although this leaves the payment of two 5p quarterly dividends uncovered, Magnus said the presence of revenue reserves with strong cash flow from its diversified investments gave the board ‘confidence’ the fund could declare a record 57th consecutive annual dividend increase later this year. It will review the situation when it declares the third dividend for the year to 30 June later this month

Longer-term performance for the blue-chip portfolio that veteran fund manager Job Curtis has run for 32 years is also solid. Overweight in financials, consumer staples and industrials, the 8%-geared blue-chip portfolio has generated a one-year total shareholder return of nearly 18%, according to the latest figures. That beats the All-Share’s 15.8% and ranks it sixth out of 20 trusts in the AIC UK Equity Income sector.

Over five years, it ranks seventh in the peer group with a 34% return that is also ahead of the All-Share’s 34.1%, according to Numis Securities.

Natwest, DS Smith and Morgan added

Other stocks that weighed on performance in the half year were housebuilder Persimmon (PSN) and US telecoms company Verizon, while reinsurance group Munich Re was the best performer, followed by oil company TotalEnergies.

TotalEnergies also provided a boost to earnings with a special dividend having doubled profits in its best year ever.

‘There were pleasing increases from the banks and oil companies in the portfolio, including special dividends from Natwest (NWG) and TotalEnergies,’ said Magnus.

‘In total, special dividends of £2.4m were received and accounted as income, representing 5.5% of gross revenue.’

High-street bank Natwest was a new addition to the portfolio, alongside paper and packaging group DS Smith (SMDS) and specialist plastics and ceramics manufacturer Morgan Advanced Materials (MGAM).

‘These purchases were partly financed by the sales of Brewin Dolphin, the private client wealth manager taken over by Royal Bank of Canada, and Synthomer (SYNT), the chemicals company, after profit warnings and the suspension of its dividend,’ said Magnus.

Inflation protection

Magnus expected inflation would fall over the next six months as the effect of last year’s oil and gas price shock starts to unwind from the numbers, although a tight labour market, higher wages, and strike action were likely to keep prices rising above the 2% Bank of England target.

He said dividend growth could help offset this inflationary pressure. ‘The dividend yield premium of UK equities over bank deposits and 10-year gilts has narrowed, but equities offer the prospect of dividend growth and can therefore provide some element of hedge against inflation,’ he explained.

City of London’s 4.7% dividend yield is among the highest in its sector and with low annual charges of 0.38%, is a popular and cost-effective way for income investors to get mainstream UK stock market exposure. Investor demand means it is one of the few trusts in its sector to stand on a small premium of 2% over NAV, a positive rating that enabled it to issue £124m of shares last year.