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Dividend trips

In a world where interest rates are close to zero, sources of high and sustainable income will be increasingly rare this year and should attract a premium value. Dividends can meet this need but investors have to be vigilant as there will be widespread dividend cuts.

The simplest way to invest in higher-yielding shares is through equity income funds, which will provide you with instant diversification and specialist management. Even so, these need to be monitored closely, and every month we monitor dividend payouts by these specialist funds.

Across the stockmarket, there is an expectation that dividends will be cut by 20-30 per cent, so the fund manager’s expertise will clearly be put to the test to maintain payouts. Yet a number of managers do seem confident they will be able to do so.

History suggests we should be positive about the potential. We have conducted research, with the help of London Business School, clearly illustrating the success of buying higher-yielding shares as a long-term strategy.

For example, in 85 per cent of 10-year rolling periods since 1900, you would have outperformed the stockmarket as a whole.

Arguably, this is the only investment strategy that is clearly proven over the long term and there were few occasions over the last 100 years when you could have started by investing when the market is 40 per cent below its peak.

Interestingly, since September 1 last year, the month from which it all got ugly, high-yielding shares, and the equity income funds which exploit their potential, are already outperforming and, in the case of the Newton higher-income fund, by a wide margin.

For example, the FTSE All Share is down by 25 per cent, the FTSE 350 higher-yield index by 22 per cent and the Newton fund by just 14 per cent. Interestingly, the Newton fund is just about the purest fund of its kind, automatically selling individual stocks when the yield drops below a certain level, where other funds are content with having a mix of stocks, so long as the average across the fund meets the yield criteria, which is 110 per cent of whatever the yield is for the stockmarket as a whole. The yield is 6.5 per cent.

In the table published here are funds invested in the UK stockmarket which, based on our calculations, meet the new criteria for an equity income fund, and which announced a dividend payout this month. We also show global equity income funds with similar objectives. In all cases, we compare the payout with the same period last year.
It is worth reiterating that we are concerned with the actual amount paid out by the fund.

This is the vital statistic for those seeking income, now or in the future. The yield is different and is a percentage comparing the amount paid out by the fund over the last year with today’s capital value, which is useful, but does not adequately reflect the skill of the fund manager, particularly for those with an income objective.

These funds are invaluable for those seeking growth or a total return as well as income-seekers. A yield of 6 per cent or more is substantial compensation until the point when capital values begin to pick up, anticipating an economic recovery.

Barclays Capital’s long-term study of stockmarket trends informs us that over rolling 10-year periods since 1899 equities have outperformed deposits in excess of 90 per cent of the time.

Add to this the knowledge that higher-yielding equities outperformed the stockmarket as a whole 85 per cent of the time and the case for growth investors to buy equity income funds is compelling.

It is encouraging that, of the 18 UK funds, only five have cut their dividends and nine have increased their dividends.
Only two of the global funds announced dividends in January, and again a Newton fund stands out, with an increase of a whopping 62 per cent compared with the same period last year.

James Harries, manager of this fund, is under no illusions: “Companies have been over-distributing. The credit crisis has resulted in a sharp increase in the cost of debt, so there will be less to distribute in the coming year.”
Many companies will also be under severe pressure from falling sales.

In the year ahead, Harries is not expecting the sharp increases in dividends of the last two years and is firmly focused on maintaining the payout, believing that robust businesses will hold their dividends.

This might not sound ambitious but, with a current yield of 5.8 per cent, just keeping the income steady has considerable attractions.

It has been a good start to the year for funds generating high, and increasingly attractive, levels of income but the toughest period for dividends lies ahead and the best fund managers will justify their salaries this year.

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