Using the Lipper Leaders scoring system to analyse the best-performing funds in the IA UK Equity Income sector.
Dividends are important again, even if investors have yet to be convinced of the importance of the UK equity market as a source for this, despite it paying a higher dividend as a percentage than other stock markets. That’s perhaps understandable, as Global Equity Income has delivered a greater total return over one, three, five, 10, and even 20 years when compared to its domestic peer, even with a lower dividend.
Some £2.6bn has been withdrawn from the UK Equity Income sector over the 12 months to the end of February. UK equities in general have been an unloved asset class for some years, particularly by UK investors. There is no end in sight to this trend.
Nevertheless, there’s 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, 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, with reference to Lipper’s more comprehensive global classifications. The compounding effect of those dividend payments really matter over time, 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.
Should relatively higher rates persist, coupled with energy scarcity then an abatement of selling pressure on UK equities could well put the pieces in place for a recovery of UK Equity Income.
Beware leverage
However, as ever in investment, there are provisos, caveats, and quid pro quos. One is that as rates rise, so does the interest on debt, and leveraged companies must service this: the more you pay out in debt service, the less you have to distribute as dividends. So, a focus on companies’ leverage will be important.
The growing role of dividends is leading to a style rotation in the UK Equity Income sector. When rates were low and growth stocks were all the rage, equity income fund managers would often drive performance through a bar-bell strategy, where a fund manager would drive performance from a basket of growth-orientated stocks, which funded the investment into the dividend payers needed to justify inclusion in the sector. When I looked at the sector in September 2020, industry weightings for the top performers were dominated by Consumer Staples, Industrials and Healthcare, with Energy being typically a significant underweight. The average dividend over the year to August was 4.3%: above that of the FTSE 100. The average yield on those funds that have performed best year to date was 3.6%: below that of the FTSE 100.
That is changing. The average dividend for the IA sector is 4.4%, and the average dividend for the top-10 over one year is 4.9%. The significant inverse relation between performance and dividend payment has evaporated—although it hasn’t been replaced by a positive correlation.
Nevertheless, a traditional dividend strategy is definitely back in fashion, with oil and gas, and tobacco stocks making up large proportions of the top performing funds in the sector. For example, the Merian UK Equity Income Fund, first-placed over three years in our table—and the only incumbent from when we last looked at the sector a year ago—has Financials as its largest sector exposure and Oil & Gas as its third.
Fourth-placed GAM UK Equity Income is also worth a mention, as it scores fives across all Lipper Leader three-year ratings. Similarly, it has Financials as the top exposure (a punchy 32.6%), although Oil & Gas is underweight relative to the FTSE 100, underweight its FTSE All-Share benchmark.
Table 1: Top-Performing UK Equity Income Over Three Years (with a minimum five-year history)
All data as of February 28, 2023; Calculations in GBP
Source: Refinitiv Lipper
This article first appeared in the November issue of Moneyfacts, page 13.
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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.
