Equity income, as your friendly neighbourhood asset manager has no doubt been telling you, is back. But “back” in this instance may not mean back geographically. Rather than returning as UK equity income—a pillar of UK investors’ portfolios for many years—global funds are moving to the fore.
Chart 1: IA UK versus Global Equity Income Fund Flows, 2003 to 2022 (GBPbn)
Source: Refinitiv Lipper
Note: the above chart covers active, merged, and liquidated funds. It does not include suspended and withdrawn funds, the inclusion of which would amplify both inflows and outflows late last decade.
UK equity income was a hardy perennial in domestic investors’ portfolios, ebbing and flowing at the top of the charts, generally between Sterling Corporate Bonds and All Companies, depending on the prevailing risk appetite. That was then…
Between 2003 and 2009, the domestic sector attracted £10.4bn, while its global equivalent took in just £1.3bn, with the UK ahead in terms of asset gathering for each of these years. From 2010, flows begin to turn in global’s favour, as the sector gathered more than UK for the first time. Indeed, over subsequent years, UK equity income has only been in the black for one (2014). Over the 20 years, global equity income has seen inflows of £6.5bn and UK equity income outflows of £2.3bn. Since 2016, the latter has suffered outflows of more than £16bn.
Both global and the UK had been in the red, flow-wise, in 2015 and 2021, which is not surprising given that the low-rate environment has not favoured the strategy.[1] What is perhaps surprising is that when the global sector returned to favour in 2022 as monetary policy tightened, taking £1.4bn, the UK was still in redemption mode, shedding £2.6bn.
From Head- to Tailwind
We’ve previously pondered the prospects of this out-of-favour asset class, which have been boosted by the return of inflation and the rate tightening that has followed this.
For the first two decades of the century, accommodative monetary policy and low rates had favoured growth stocks such as technology, as this environment increases the value of future cash flows—expected growth—relative to current ones (dividends).
UK equity income was further hit by the suspension of many dividends from FTSE 100 members in the COVID crisis. However, performance has rebounded since the “vaccine rally” of November 2020, and the market has in general favoured income-paying stocks subsequently.
All this should have been grist to the diesel-powered mill of the UK equity income sector over the past year, propelled by the outperformance of energy and financials coupled with the tanking of tech. Certainly, UK equity income enjoys structural biases that should have served it well in this market, compared to its global peer. For example, global equity income has a whopping 12.9% overweight to tech relative to its UK sibling—the largest difference between the two at a sector level. Meanwhile, it is underweight financials by 4.6% and energy by 4.5%, with the global sector at slightly more than half the weight of the UK (chart 2).
Chart 2: UK Equity Income and Global Equity Income, Relative Sector Weights, 2022
Source: Refinitiv Lipper
That, however, is not what happened. The 2022 returns for the IA UK Equity Income sector were -2.2%, with the IA Global Equity Income sector returning -1.7%. The other sector differences seem unlikely to compensate because they simply aren’t big enough. Global also has both a lower 12-month standard deviation (3.5 versus 4.5) and a lower beta (0.73 versus 1.06) compared to UK Equity Income.
Table 1: UK versus Global Annualised Performance
Source: Refinitiv Lipper
Over the course of all main reporting periods—from one to 20 years—global beats UK. Some of this may be fallout from the selling pressure that UK equities have been under throughout the course of the century, as pension funds shifted from equities to bonds, and UK investors across the board reallocate from domestic to foreign equities: something we’ve taken a deeper dive into here.
There’s certainly a case to be made for UK equities from both a valuation and dividend perspective, which has been unfolding over the past year. This plays to UK Equity Income’s more “traditional” flavour from a sector perspective which should be working in its interest, as does the greater role that dividends pay in the UK—the greatest of any global stock market. This is reflected in the weighted dividend for UK Equity Income, 4.38%, as opposed to 3.02% for its global equivalent for the year to the end of February. The compounding effect of those dividend payments really matter over time, as can be seen by chart 3, comparing the FTSE 100 total return against the index’s return on a price-only basis—247.5% versus 65.6% over 20 years to 28 February 2023.
Chart 3: The Role of Dividends in the FTSE 100’s Total Return
Source: Refinitiv Lipper
If this elevated rate environment remains in place, coupled with energy scarcity—as is the consensus—then an abatement of selling pressure on UK equities could well put the pieces in place for a recovery of UK Equity Income.
[1] The majority of the £8.2bn outflows from Global Equity Income in 2018 comes from just three share classes of separate funds
This was published in FTAdviser.
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