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Dividends that may not pay off

The fall in interest rates to 0.5 per cent should finally have brought a smile to the face of many UK equity income managers.

The sector has been split amid concerns of an overemphasis on performance returns rather than managers producing the appropriate yield. Add to this the financial Armageddon of the past 18-24 months and it has not exactly been the rosiest time in the sector.

But all of a sudden, the search for yield has put a spring in the step of a number of UK equity income managers and, alongside the UK corporate bond sector, it was the popular choice for investors in the 2009 Isa season.

But are the storm clouds gathering once again?

Barings Asset Management marketing director Ian Pascal is warning that some income funds will fail to deliver on the attractive yields being marketed to investors.

He says that while they may be attractive in comparison with deposit accounts, people may not realise that the yield target is calculated historically and that dividends are set to dwindle, especially after what has happened in the banking sector.

Pascal says: “Firms will highlight that fact but I still think people will be attracted by those numbers and some will be disappointed by the cheque they receive in the post.

“The other issue is that the fewer companies there are paying dividends, the more that fund managers will start to chase those with higher dividends. This will push the share price higher and ultimately pull those yields back down.”

M&G dividend fund manager Richard Hughes disagrees, pointing to dividend cuts having come earlier in the cycle.

Recent research from M&G reveals that 47 of the FTSE 100 companies that have reported their results this year have increased their payouts by more than 10 per cent.

Hughes says: “Dividend payouts are perhaps more resilient than people might have gathered from newspaper reports – 34 of the 47 blue-chip companies that have announced final results have raised their dividends. Despite a difficult economic backdrop, many companies still have strong cashflows, strong balance sheets and, in many cases, good dividend cover.

“Companies are cutting their dividends very early in this cycle. In past recessions, they have generally continued to pay dividends for the first one or two years pending an economic recovery after an 18-month recession.

“I believe this change has been sparked by fears over how deep and how long this recession will be as well as concerns over the availability of credit.”

Henderson UK equities fund manager Graham Kitchen says that with up to half of the FTSE 100 expected to cut or suspend dividend payments this year, the outlook may appear bleak but good stockpicking will see managers continuing to offer stable yields and capital performance.

Kitchen highlights a number of companies still paying a higher dividend as examples.

He says: “AstraZeneca is currently yielding more than 6.8 per cent while the utility company National Grid is providing investors with an income of 6.4 per cent. Importantly, 50 per cent of UK dividends are reported in dollars so dividend payments have been, and will continue to be, supported in sterling terms by the strength of the dollar.

“Our focus remains on companies with robust balance sheets who have the ability to survive the downturn and continue to pay a dividend. Conversely, we aim to avoid value traps, such as highly indebted cyclical names whose current high yields may prove to be illusory.”

Maia Capital Partner Jason Collins says the fear is that some fund managers will start to chase yields. He says: “That could see some fund managers tripping themselves up by ending up in the wrong kind of stocks. The important thing is that fund managers continue to focus on companies with strong balance sheets.”

Bestinvest senior adviser Adrian Lowcock says: “We can expect to see historic yields fall throughout the remainder of 2009. I think investors should be happy with yields in the region of 4 per cent.

“Investors could look to some of the enhanced-income products that go towards 7 or 8 per cent yields thanks to Ucits III, and I believe they can hit those targets.”

Hargreaves Lansdown head of research Mark Dampier says the majority of fund managers he has spoken to have said they either expect to maintain or slightly grow their dividend yield this year.

He says: “This is a great time with income funds offering yields of 5 per cent compared with 0.5-0.6 in cash accounts.

“I think that much of it has to be judged on a fund by fund case but a lot will depend on what dividends the likes of BP and Shell produce as they are the big players. Most have taken into account what is happen- ing with banks so that should not be a factor.”

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