One of the big concerns for investors in the UK equity income sector is the concentration of companies paying reliable dividends.
BP’s suspension of its dividend in the wake of the explosion of its drilling rig and the oil spill in the Gulf of Mexico last summer showed just how reliant the sector is on a small number of high-yielding stocks.
Before BP suspended its dividend for 2010, many UK equity income funds had between 4 and 5 per cent of their assets in BP and it is not hard to see why.
According to the latest edition of the Capita Registrars UK dividend monitor, 46 per cent of all UK dividends in 2009 came from just five companies – GlaxoSmithKline, Vodafone, HSBC, Royal Dutch Shell and BP. BP accounted for 14 per cent of UK dividends by itself.
The latest monitor shows this concentration of dividend-paying stocks eased slightly in 2010, with the top five holdings responsible for 38 per cent of all UK dividends paid. However, 61 per cent of dividends are still produced by only 15 companies, and the FTSE 100 pays 90 per cent of all UK dividends.
If a major problem, such the Deepwater Horizon spill, happens, the impact on investors can be disproportionately high and can affect almost all the funds in the sector.
Despite a general increase in the size of dividends paid in 2010, the cut of BP’s dividend was enough to cause a negative effect overall.
The Capita data shows companies paying dividends increased their payments by an average of 7.5 per cent in 2010 but BP, and the handful of other super-dividend payers, contribute so much to the overall dividend pool that the total of all dividends paid in 2010 fell by 3.3 per cent from the previous year.
Capita Registrars chief executive Charles Cryer says: “Despite the return to growth, UK income investors are still reeling first from the financial crunch and then the BP Deepwater Horizon accident. The heavy dependence on few companies for the bulk of our dividends exposes investors to a lot of risk.” Despite cancelling three out of four scheduled dividend payments, BP was still the seventh -biggest dividend payer in 2010.
Cryer says this illustrates well the concentration of the UK dividend universe.
He says: “Small and mid-cap companies were hit hard in the recession and slashed their dividends to the bone as they sought to survive the crunch. They have recovered dramatically but their contribution and their rapid growth is swamped by small changes to the UK’s biggest firms. The amount paid by the FTSE 250 last year was less than the three payments BP cancelled.”
This concentration of UK dividend payers means investors in the perennially popular UK equity income sector are perhaps unwittingly increasing the risk they are taking.
Chelsea Financial Services managing director Darius McDermott says the company first became concerned with this trend over a year ago and have had to take steps to reduce this concentration. He says: “We recognised this concentration issue about 18 months ago and when we looked as a firm where our money was placed, it is very lumpy with the top income franchises. BP highlighted this more than ever last year. We had an investment dinner in May of last year on this very issue, which was diversify your income because it is just too narrow now.”
He says having looked at the top funds in the sector, apart from the contrarian approach taken by Neil Woodford, all the top funds have concentrations in the same stocks.
He says: “There was at least two or three of the top five paying dividend stocks in every portfolio because there has to be as they pay so much of the dividend.
“For people behind the curve, BP was a real wake-up call for that concentration factor on equity income.”