by Dewi John.
Equity income, lagging and unloved for so long, seems well positioned for a comeback. There are signs that this may be turning the corner, as consistently negative flows to the UK Equity Income sector have reversed over the three months to the end of July, with these funds taking £493m.
Much of the case for equity income rests on how present rather than future cash flows are valued by markets, depending on base rates. From the start of the twenty-first century until COVID drove a wrecking ball through global supply chains, we had lived in a world of accommodative monetary policy, low inflation, and commensurately low rates. That has favoured growth stocks such as technology, as it increases the value of future cash flows (expected growth) relative to current ones (dividends, which are the backbone of equity income). Higher rates throw this into reverse, with current cash flows being more valuable.
That’s good for the UK market, as it’s historically been more dependent on dividends for its total return. It’s also panned out relatively well so far recently, as UK equities were not hit quite so hard by the global equity market falls that beset the start of the year. What’s more, UK equity income has outperformed its “regular” All Companies equivalent over 12 months (by -4.3% to 2.1%).
But, for all its importance, the UK is not the only equity income game in town. There are other equity markets globally where dividends play a significant role. In the US, for example, equity income has outperformed the broader market over 12 and three months.
Within the Investment Association Global Equity Income sector, Lipper characterises 32 funds as value, four as core, and none as growth. Nevertheless, the sector has a smaller dividend yield than its UK equivalent: 3.1% compared to 4.3% over 12 months to the end of July. Both sectors, however, are on an upward trend dividend-wise, each having risen by more than half a percent over the past four months.
The leading fund over three years is the JPM Global Equity Income. It’s top holding is Microsoft—not what you might think of as a typical dividend payer—and at less than 0.9% dividend yield, you’d be right. But it’s not unusual for equity income managers, particularly over the past few years, to seek the best of both worlds by funding the dividend payers in their portfolios through allocations to more growthy plays.
What’s perhaps surprising is to find this is the case with the tracker fund in the top 10—the Fidelity Global Quality Income UCITS ETF, with Apple and Microsoft as its two top holdings. But, again, it needs to be born in mind that the fund is targeting the average weighted dividend, delivering 2.5%.
Such a barbell approach will have served those using it well up until growth—particularly in the form of tech leviathans such as Microsoft—ran into trouble after a long purple patch. But over the longer term, it’s been a good strategy.
Another potential benefit for the global equity income sector compared to the UK, certainly for ethically inclined investors, is that there’s slightly more to choose from as a proportion of the universe. Ten of the 47 funds are flagged as ethical by Lipper, meaning they use some form of environment, social, and governance (ESG) element in their investment process. That tends to be less the case in the UK, given the greater dependence on oil, gas, and tobacco stocks for dividend payments.
In a period where base rates are significantly higher than has been the case for the past two decades, then dividend paying stocks are more likely to outperform. Given that UK investors are generally overweight domestic equities, this could be a way to ride the income wave without exacerbating that position.
Refinitiv Lipper delivers data on more than 330,000 collective investments in 113 countries. Find out more.
The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.