FOR decades the UK Equity Income sector has been the foundation of many UK investor portfolios and has been home to a number of our most celebrated fund managers.
However, the traditional approach to generating income from a UK equity portfolio has increasingly come under threat with a number of the large dividend-paying sectors cutting their dividends.
In the past few weeks we have seen a range of household names such as Vodafone, Royal Mail and Marks & Spencer all cut their payments to shareholders.
When companies such as these start cutting their dividends the impact on returns is pretty grim – you lose vast amounts of both capital and income.
Too often UK investors find themselves reliant for income on a small number of high-yielding businesses whose best days are behind them and where dividend payments are fragile.
The UK stock market is pretty much unique in having an unhealthy concentration of dividend payouts, with 56 per cent of all income coming from just 15 of the index’s largest companies.
The problem is that these companies tend to be clustered around mature, low-growth sectors including oil and gas, banking, telecoms and utilities.
That means that if you invest in the index for income you are heavily reliant on giant businesses for your dividends, with 86% of total UK income now coming from the FTSE100.
You can achieve high yields from investing in UK shares, but there is significant concentration risk in doing so and you are investing in companies that are mainly in decline
A strategy of sticking to your home market has not been a profitable one since the Brexit vote in mid 2016 and you would have fared much better investing outwith the UK, where returns have been greater and where a weaker pound would have enhanced your gains.
Overseas investors in particular have been running a mile from UK stocks and we have seen persistent redemptions in UK funds of late, with recent analysis by Barclays suggesting that around £40 billion of total assets have been lost from UK funds since the referendum.
This is backed up by surveys such as Bank of America Merrill Lynch’s global fund manager survey, which confirmed that asset managers have never been more negative on the UK market than they are currently.
All of this Brexit-related uncertainty has meant that the dividend yield on the UK market is now at very high levels, with the MSCI UK Index yielding around 4.5% today compared to around 3% for the MSCI World Index.
Things become even more extreme when you compare UK equity yields to those from UK gilts, where 10-year yields have now fallen below 1% for the first time.
The current gap of almost 3.5% has reached levels not seen since the Second World War.
So as we sit here today the UK stock market looks pretty friendless among investors in general, with UK shares remaining a hugely unpopular investment despite some very high dividend yields on offer.
As value investors this has been a tricky environment for us to navigate in recent years, but we now think that the pessimism is overdone.
The opportunities for value investors have rarely been greater and the appetite for value investing has rarely been less than it is today.
As investors in general pay ever-inflated prices for safe or high-growth assets we think that the odds are now strongly in favour of investing in a broad range of unpopular UK shares.
The financial sectors such as banks, insurers and real estate offer very high dividends and low valuations and could recover strongly if there is ever any resolution to Brexit .
Other companies such as WPP, Standard Life Aberdeen and Imperial Brands are highly out of favour with investors at the moment but could offer great recovery potential and good dividend income while we wait.
The key is to avoid the dividend traps while embracing the genuine bargains.
It may well now be time to look at some ugly ducklings.
Scott McKenzie is investment director at Saracen Fund Managers.
Why are you making commenting on The Herald only available to subscribers?
It should have been a safe space for informed debate, somewhere for readers to discuss issues around the biggest stories of the day, but all too often the below the line comments on most websites have become bogged down by off-topic discussions and abuse.
heraldscotland.com is tackling this problem by allowing only subscribers to comment.
We are doing this to improve the experience for our loyal readers and we believe it will reduce the ability of trolls and troublemakers, who occasionally find their way onto our site, to abuse our journalists and readers. We also hope it will help the comments section fulfil its promise as a part of Scotland's conversation with itself.
We are lucky at The Herald. We are read by an informed, educated readership who can add their knowledge and insights to our stories.
That is invaluable.
We are making the subscriber-only change to support our valued readers, who tell us they don't want the site cluttered up with irrelevant comments, untruths and abuse.
In the past, the journalist’s job was to collect and distribute information to the audience. Technology means that readers can shape a discussion. We look forward to hearing from you on heraldscotland.com
Comments & Moderation
Readers’ comments: You are personally liable for the content of any comments you upload to this website, so please act responsibly. We do not pre-moderate or monitor readers’ comments appearing on our websites, but we do post-moderate in response to complaints we receive or otherwise when a potential problem comes to our attention. You can make a complaint by using the ‘report this post’ link . We may then apply our discretion under the user terms to amend or delete comments.
Post moderation is undertaken full-time 9am-6pm on weekdays, and on a part-time basis outwith those hours.
Read the rules here