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Yield fears for income funds

Newton higher-income fund manager Tinekke Frikkee has warned investors that yields offered by UK equity income funds could plummet by the end of this year.

Frikkee says investors should not rely on the FTSE yield data as it always assumes that once an interim dividend is paid, a final will also be paid unless stated otherwise.

Frikkee says in times of turbulence, the published dividend yield tends to overestimate the eventual annual dividend. She says this is then followed by step-change falls in published dividend yields as official notifications catch up with wider expectations of cuts.

She says: “The most extreme example of this was in November of last year when severe market weakness drove the yield on the FTSE All Share to a 28-year high of 6.11 per cent. A week later, when the dividend cuts made by the UK banks were factored in, the yield on the FTSE All Share dropped to 4.7 per cent. Since then, further dividend cuts and rights issues, coupled with strong price performance, have pushed the market’s yield down to 3.5 per cent.”

Frikkee says yields in the IMA UK equity income sector have already fallen in recent weeks after funds went ex-dividend at the end of June.

She says: “We expect to see this again in December as those managers who do not adjust their portfolios could face a serious hit to the dividends they collect. In September alone, the interim dividends from Rio Tinto and Legal & General will be down by 100 per cent and 55 per cent respectively, while October will see a 100 per cent cut in Rexam’s interim dividend.”

The warning does seem to have substance. Although analysts are anticipating yield levels sticking around the 5 per cent mark for the next year or two, the dividend swap market – where you buy and sell future dividends for cash – has been at half that level, indicating that the overall yields could be far less.

Principal Investment Management investment manager Joe Wiggins says there are always likely to be drops in dividends from those UK equity income funds that are positioned more aggressively for capital growth.

He says: “We have seen some chasing capital growth over dividend and they will be the ones who will have to make changes rather than the more defensive offerings from the likes of Frikkee and Neil Woodford.

“The FTSE historic yield is problematic and the new IMA rules for UK equity income funds are illusory at best. I think the falls will be disparate, with some being in line with the market at around 20 to 25 per cent dividend cuts.”

Jupiter income trust fund manager Tony Nutt says dividends are likely to sustain, with only some of the top-end higher- yielding companies cutting.

He says: “I think it will get better next year as the economy continues to settle down. The trend is modest for dividend growth but we have had the bulky ones from the banks. The big issues are whether oils, pharmaceuticals and telecoms cut their dividends and the answer is no. The only worry is on the small number of companies responsible for large portions of dividend.”

Six stocks in the shape of HSBC, Shell, BP, Vodafone, GlaxoSmithKline and AstraZeneca account for 50 per cent of dividends in the market while 19 stocks account for 70 per cent of the market.

Liontrust first income fund manager Gary West says: “I believe the consensus for UK dividend payouts this year is for a fall between 15 per cent and 20 per cent. The expected decline this year has been moderated to a degree by the growth in sterling dividends from both BP and Shell. They base their dividend pay-outs in dollars and the weakness of sterling relative to the dollar earlier this year has led to strong growth in reported dividends from two of the biggest dividend- payers in the UK.

“We have also found so far this year that our investment process, which focuses on companies with strong free cashflow, conservative balance sheets and shareholder-friendly management, has helped us identify sustainable dividends. Recent examples would include IMI, Next and Ashmore, all cyclical businesses that have managed the recessionary impact on their cashflow and balance sheet extremely well and have decided to hold or increase their dividends this year.”

Schroder income manager Ian Lance says yields are not the full picture as some investors are keen for both income and capital growth from a UK equity income fund.

He say: “We took the view earlier this year that those companies offering dividends are fully valued and we do not think that paying over the odds for an income-paying company is the right view, particularly as those which are not paying an income appear undervalued. That view has led to the income falling in favour of capturing capital growth.”

Lance says although we have started to see dividends fall in UK equity income funds in recent weeks, it is more a result from the shake-up of the banking sector and other cyclicals than any further concerns.

“I feel that we have seen the worst of dividend cuts while there are also a number of stocks which may well increase their dividends following what has been a traumatic 12-18 months.”

Skerritt Consultants head of investments Andrew Merricks says: “We are still fearful of dividend cuts and have been steering clear of UK equity income funds in favour of corporate bond funds.

“The impression is that there may be more out there in terms of cuts following what has already happened with the banks.”


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