22nd February 2013
According to Brian Dennehy, managing director of FundExpert.co.uk, those funds with a wide geographic mandate – they can put their money into any investible market – fared the worst with two thirds reducing their payouts, while 60 per cent of European funds and 50 per cent of Asian funds also decreased payments to unit-holders.
In its list of “saints and sinners” FundExpert named and shamed Newton European Income as the stingiest fund. It cut payouts by 24 per cent in 2012. Most generous was JP Morgan’s UK Strategic Equity Income Fund, which, coincidentally, grew dividends by 24 per cent.
Dennehy largely blames the payment fall on the economic downturn in Europe, which he believes has “played the major role in denting companies’ enthusiasm to increase payouts”.
In detail FundExpert finds: “There are 25 equity income funds with a global mandate (only funds over £50m are reviewed). Of these, 15 cut their payouts in 2012, compared to 2011 where the vast majority increased payouts. Overall, 56 per cent of non-UK funds cut their payouts.
This breaks down into 64 per cent of global funds cut, 60 per cent of European, and 50 per cent of Asian funds. The two US funds in the survey increased payouts, but the yields are so low as to be worthless to income investors.”
Questioning the numbers
But while there is no argument with Dennehy’s figures, the concentrated focus on growing dividend income can be questioned with another leading IFA taking him to task over his assertion that “in 2012, funds failed investors on the most basic requirement: growing their payouts” while a top fund manager warns that investors seeking high income from equity funds are “delusional”.
Dennehy says much of the good performance in the UK equity income sector is a catching up process after the 2008 crash and the fallout from the BP Gulf of Mexico disaster which pushed the oil giant off the dividend list for a time – even now it is not back to pre-explosion levels. BP at its height accounted for one pound in each seven of UK dividend income – the vast bulk of the rest of
dividend income arises from no more than a dozen or so companies.
The research points to two vital questions. How important is growing a dividend in the hierarchy of investor requirements? And while historic figures can be interesting, what should investors do going forward?
Total return not dividend growth
Investors can assess the numbers in a different way if they look at total return – dividends and capital growth/shrinkage. This total return is effectively the same as re-investing income into new units (or into re-investment units). Many investors do this when they do not need payouts. Figures for the two sectors, global equity income and UK equity income from Trustnet show a remarkable similarity in total returns over recent years. Global equity income rose 16 per cent and 37 per cent over one and three years respectively – helped by sterling weakness – while the UK equivalent rose 15.7 per cent and 38.5 per cent. As these are averages, the conclusion must be that there is little to choose from although there is a wide variation at the individual fund level.
Dennehy says: “Many global equity income funds were launched with a flourish in recent years, but in 2012 failed investors on the most basic requirement: growing their payouts.”
But is “growing the payout” – on which all his research is based – the “most basic requirement”?
“A definite no,” says Adrian Lowcock at rival Hargreaves Lansdown. “Other than some Asian countries, the UK is unique in its dividend culture as these payouts play a less less important role elsewhere. And when Royal & Sun Alliance unexpectedly cut its dividend earlier this week, the market punished it with a 16 per cent equity price fall. That’s a far bigger hit than the dividend fall. I believe that the most basic requirement is maintaining capital, not growing the payout. There is a danger that companies can increase the dividend at the expense of not spending enough on capital projects or on research. Companies need to grow. Investors should never buy dividends and sacrifice capital growth. ”
He says: “If a company with a share worth £1 has a 5p dividend, investors get a five per cent yield. But if that price doubles to £2, and the dividend rises to 6p, the yield drops to three per cent, while if it stays at £1, the yield remains a more impressive five per cent. Many equity income managers would sell as the yield drops, re-investing capital gains.”
Lowcock adds: “Which would you rather own – a company with strong share price growth or one that goes nowhere or backwards but is very generous on the dividend front? The key component of a dividend-oriented strategy is a company with good solid cash-flow plus growth in its business. If you have dividends without growth, then it becomes unsustainable.”
Investors can become delusional
Terry Smith, who runs management firm Fundsmith, goes further than “unsustainable”. He believes investors looking for high equity yields are “delusional”.
He says: “If investors think that they can get an income of 4 or 5 per cent after fees, and that their capital will be returned, I’m afraid they are delusional. ‘If fund managers think this is possible, they should take up alchemy as a profession, not investment management.”
‘Going forward’, Dennehy warned, “the results for income investors will continue to vary hugely, and vigilance is vital. Investors and advisers must be much more aggressive in sorting out the wheat from the chaff.” He recommends Artemis Global Income and Newton Asian Income.
“Yes,” agrees Lowcock, “investors need to diversify especially as so many UK income funds rely on the same small roster of stocks which does not offer much in spreading risk. There is obviously a greater potential of getting it wrong once you go outside this safety zone but you can’t rely on the UK sector. I like Invesco Perpetual UK Income and Artemis UK Income but I would balance that out with JO Hambro UK Equity Income for its smaller and mid-cap stocks, Newton Asian Income, Newton Global Higher Income and JPM Global Equity Income.”
Lowcock adds: “Look after the capital first, and don’t make a dividend rod for yourself. Look at Newton Higher Income – it prioritised dividend over capital. It has now changed its manager and is aiming at a lower yield.”