There could be some light at the end of the UK dividend tunnel in the months to come, says Andrew Pitts.
The recent performance of equity income-focused funds and investment trusts has been poor, to say the least, and the outlook for income-seeking investors appears to be unremittingly gloomy.
That is certainly true in the UK: Link Asset Services’ UK Dividend Monitor for the third quarter of 2020 showed that UK dividends fell by 49.1% compared with the previous year, dropping to £18 billion – the lowest level for a decade.
The cuts were less severe than in the second quarter, with Link reporting that around two- thirds of companies cut or cancelled payouts, compared with three-quarters between April and June. For the year as a whole, Link forecasts UK dividends to be between £59.9 billion and £60.4 billion (excluding special payouts) – a decline of around 39% on the 2019 total.
However, there is now some light at the end of the UK dividend tunnel. Link’s forecast is for dividends to recover in 2021 by 15% on the 2020 total in a best-case scenario, but by just 6% in a worst case. Nevertheless, that only takes total payouts from UK companies back to levels last seen in 2012 or 2013 (depending on the strength of the bounce back).
The interactive investor Active Income and Low Cost Income portfolios target 25% exposure to UK equities, with active income currently a few percentage points higher than that. The higher overall weighting to overseas equity income strategies has helped to save both portfolios from the ravages that have been visited on UK companies. So far in 2020 (to the end of October), for example, the Vanguard FTSE All World High Dividend Yield (LSE:VHYL) exchange-traded fund has lost -14.4%, compared with a -29.5% loss from the UK-focused Vanguard FTSE UK Equity Income Index fund.
Clearly, it is not easy for either of ii’s income-focused portfolios to generate positive returns in such an environment. But when sentiment improves – and the signs in early November are that bashed-up income stocks are staging a tentative recovery – overall portfolio performance should also bounce back.
How the two ii income model portfolios are performing*
|% total return (with income reinvested) as of 31 October 2020, after:|
|1 month||3 mths||6 mths||1 year||Since inception*|
|ii Active Income||-3.2||-1.6||-0.4||-13.7||-1.7|
|ii Low Cost Income||-2.6||-0.6||1.6||-13.5||-3.8|
|Morningstar GBP Adventurous Allocation average||-1.7||1.0||7.3||-0.9||11.9|
Notes *as at 31 October 2020. Portfolio launch date (for monitoring purposes) was 1 January 2019, except Ethical Growth portfolio, , launched 1 October 2019. Data source: Morningstar Direct.
Standout stat: Murray International has revenue reserves equal to 1.1 years of the previous year’s total dividend.
Among the portfolio’s seven equity-focused holdings, Utilico Emerging Markets (LSE:UEM) investment trust was among the best performers in October – in common with the developing-markets funds that the growth-focused portfolios hold.
However, this did not translate into actual gains – with the share price total return falling by -3.2%, a little more than the -2.3% drop in its net asset value. The trust has recently stated that its current income payouts – it yields 4% with dividends paid quarterly – are fully covered by underlying dividends from holdings in its portfolio, which is reassuring. The trust trades on a near 13% discount to its net asset value (NAV), which is a little higher than its 12-month average.
Fellow investment trust City of London (LSE:CTY), a favourite holding among interactive investor customers, experienced the opposite to Utilico. Although its NAV total return also fell, by -4.4%, the share price total return was down just -0.9%, while its premium increased to 2.5% compared with a 12-month average of 0.3%. On 31 October, the trust was yielding 6.3%.
Murray International (LSE:MYI) also has a high yield at present, offering 5.7%. Like Utilico Emerging Markets, it also saw its share price total return fall a little further than its NAV, -3.5% and -1.6%, respectively. But among the high yielders in the portfolio, its dividend looks the most secure as it will be reluctant to break its progressive dividend record since manager Bruce Stout took charge in 2004.
Kevin Carter, chairman, states in the trust’s interim report to 30 June that: “The board currently intends in 2020 at least to match the dividend payout of 53.5p per share in 2019. It is expected that this will entail some use of the significant revenue reserves built up over prior years for occasions such as the current crisis.”
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According to data from Morningstar, reserves for Murray International amount to 1.1 years of the previous year’s total dividend. In contrast, City of London’s reserves have dwindled to 0.58 years of the previous year’s total.
The mantle of highest-yielding holding in the portfolio goes to Man GLG Income, which on our portfolio valuation point of 31 October yielded 7.1%. But as the yields quoted are historic, rather than prospective, and with market dividends forecast to be down 39% on 2019, it remains to be seen where manager Henry Dixon can conjure up the income from the portfolio’s 70 positions. Just over 55% of the portfolio is in the FTSE 100 index and 33% in the FTSE 250.
However, an encouraging trend has recently developed when comparing the annual change in the fund’s monthly dividend payments. Between March and July, they were down between 39.6% and 18.8% on the equivalent periods in 2019. But in August, the payout fell by just 6.3% on the previous year and in September, it was unchanged. That bodes well for the rest of the year, particularly in relation to the cuts seen in the wider market.
When assessing the performance and yields of UK-focused funds, investors need also to bear in mind that what funds lack in income they might be able to make up in total return, if recent market moves are any guide. The FTSE 100 had risen more than 700 points from the turn of the month to 11 November, a gain of 11%-plus.
On a weighted basis, the ii active income portfolio yields 4.2%, usefully more than the 3.4% historic yield from the Low-Cost Income portfolio.
Standout stat: with a loss of -3.8% since inception, the portfolio is ahead of the Income benchmark loss of -5.6%.
Only one of the portfolio’s nine holdings made a gain in October, and a paltry one at that. The SPDR S&P Global Dividend Aristocrats ETF (LSE:GBDV) was up just 0.3%, with the next best holding being the hedged-to-sterling share class of Vanguard Global Bond Index, which was unmoved over the month.
UK-focused holdings again took the wooden spoon in October, with SPDR S&P UK Dividend Aristocrats ETF down -5.3% and Vanguard FTSE UK Equity Income Index fund not far behind, losing -4.7%.
A standout difference between the two funds is the historic yield: the Vanguard fund’s 6.8% yield is far higher than the 3.6% for the UK Dividend Aristocrats. But the more discerning strategy of this ETF – to invest in around 40 UK companies that have held or increased dividends for at least seven years – also translates into lower losses. With income reinvested, the ETF is down -16.7% on a 12-month view compared with -24.7% for the Vanguard fund. Over three years, annualised losses amount to -6% versus -8.4%, respectively.
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Strangely, the picture is reversed for two of the global equity income funds in the portfolio, which account for just over 30% of the total. SPDR S&P Global Dividend Aristocrats ETF is down -20.6% over one year, compared with a -11.9% loss for the Vanguard FTSE All World High Dividend Yield fund.
Andrew Pitts is an independent consultant for interactive investor and was formerly editor of Money Observer magazine from 1998 until 2015.
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