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Income in the East


The concentration of dividend payouts from a shrinking number of UK stocks is leading investors to seek income elsewhere. While foreign income oriented funds have been around for some time, these vehicles are gathering interest as equity income investors look for greater diversification.

At the recent London venue of the Unique Boutiques roadshow, Dominic Neary, manager of Baillie Gifford’s Global Income fund, surveyed the audience of advisers to determine their current level of interest in products such as his. More than half the audience said they were now recommending a global equity income product as compared with even just a couple of years ago.

With the statistics on dividends skewed more towards a worldwide approach to income investing, it is not surprising to see why.

While Neary commented that the UK is undoubtedly the traditional home for equity income investing, its market has shrunk while in other regions it is growing. The top 10 contributors of income in the FTSE make up more than 60 per cent of the entire UK market income. “It has become incredibly concentrated,” he said.

Henderson New Star manager Mike Kerley is also not enamoured with the current state of the UK equity income market, calling it oncentrated and constrained. Almost 50 per cent of dividend income in the UK market is coming from just six companies, he says, adding that 25 per cent comes from just two oil companies. “There is a lot of risk for dividends in the UK as it has become so dependent on oil and their overseas income. If investors are so interested in companies with overseas earnings, why don’t they just invest in overseas equities instead?”

Neary pointed out the US offers diversification as well as dividend benefits, and not just in the region’s largest companies. “If you exclusively look for the high yields you end up with very mature companies, which can lack growth,” he said.

Echoing the need for proper balance between growth opportunities and yield plays is Jupiter’s Malcolm Millar, manager of the group’s European
income fund. He too believes foreign income funds are gaining in popularity with short term factors, such as sterling weakness and the UK’s economic woes, emphasising the longer-term story of the need for diversification.

With investors so conditioned to the UK being the epicentre of dividends, Millar says Europe is a natural first step for investors. He says that contrary to the perception that the UK’s yield is higher than Europe’s, the two markets are on comparable levels. The oft quoted criticism of dividend cultures outside the UK is that companies do not see them as important and are quick to make cuts in difficult times. But Millar contends that Europe is no better or worse than the UK in terms of dividend reliability, noting it has been a difficult period for all companies. He now anticipates a return to dividend growth and at a similar 10 per cent level as the UK.

Like Neary, Millar believes it makes sense for equity income investors to diversify and other regions can offer a wider spectrum of sector exposures. While the oil and gas and mining sectors tend to high yielders in the UK, in Europe it is more skewed towards industrials, pharmaceuticals, utilities and telecoms.

Neary does not advocate taking just a Western approach to dividend opportunities, believing the much anticipated superior growth opportunity of emerging markets will soon feed through to higher dividend payouts. As such, he expects the emerging market portion of his fund to rise in the future. He points out that China is already providing a yield of around 4 per cent plus it has exciting growth opportunities to provide capital uplift at the same time.

He expects the emerging market portion of his fund to rise in the future. He points out that China is already providing a yield of around 4 per cent plus it has exciting growth opportunities to provide capital uplift at the same time

He is not alone in that assertion. Kerley, who manages the Henderson Far East income investment trust and the New Star Asian dividend income unit trust, is buoyant about the income opportunities in the East.

He concedes that Asian countries are, by and large, at the early stages of a dividend culture, but he points out it can only increase from here. Asian dividend-payers are also not concentrated into one or two sectors but opportunities can be found across a range. He compares the UK’s reliance on six companies to provide half the overall market yield with 38 companies in Asia that account for half the market yield.

Kerley says it may appear as if Asia is all about beta but when returns are broken down, just like the UK market, income makes up a large proportion.

Around 47 per cent of returns from the region come from income, not share price performance, he says. As to the question of whether or not dividends in the region are sustainable, Kerley says Asian companies learned a lot from the 1998 crisis. Companies have strong free cashflows, low debt and their payout ratios in terms of dividends is still quite low as a percentage of profits. This means that even if a company’s profits stagnant or fall, they have the ability to keep raising their dividends.

Still, Kerley does not discount the attractive capital growth aspects of the region. Around 50 per cent of his portfolios are invested with companies that already feature high yields but the other half are in firms with lower than average yields currently but where he expects to
see both capital appreciation and dividend growth.

Kerley also makes use of derivatives to boost his overall yield, which is just over 4 per cent on his portfolios. He describes his use of derivatives as opportunistic and conservative but says it can add around 100-150 basis points to income in the fund each year. “They do not increase my volatility and I have a reduced turnover because I do not have to chase yield and I can take a longer-term view on companies,” he says.

With the end of the Isa season in sight and the emphasis still on income- producing investments, foreign income funds may be a popular, if unheralded, beneficiary.


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