BP concerns highlight UK funds’ imbalance

Asia and the US are throwing up more opportunities for income investors than the UK stock market, according to global fund managers – and even more so as uncertainty over BP’s dividend continues.

Fears that the oil company’s 2010 payout will be suspended because of the Gulf of Mexico oil spill have caused problems for managers of UK equity income funds. This is because BP’s dividend accounts for as much as 15 per cent of the total income from the FTSE 100 – making it a top holding in a lot of the UK’s top income funds.

Bestinvest, the financial adviser, has worked out that BP is the largest holding in 40 out of 86 UK income funds. Another 23 also have a holding in BP. In some funds, the holding is approaching 10 per cent.

Tim Cockerill, head of research with Ashcourt Rowan Asset management, believes it is time for UK investors to look elsewhere for their income. “The UK market is very top-heavy, with a small number of companies providing the bulk of the dividend from the stock market as a whole, and the risk in this is neatly highlighted by the plight of BP. If they cut the dividend, then that is going to be a big blow for a lot of income portfolios and funds.

“After years and years of being restricted to the UK, there is now opportunity elsewhere – which provides diversification and the chance to have exposure to some exciting areas such as Asia and emerging markets.”

And UK fund houses are keen to roll out new varieties of income funds. Just this week, Aberdeen unveiled plans to add a Latin American income fund, which will invest in a mix of income stocks and sovereign bonds. The first of its kind to list in the UK, it is expected to yield 4.25 per cent.

Stuart Rhodes, manager of M&G’s global income fund, says the key is to focus on growing companies with excess cash. His internationally focused fund has outperformed the FTSE 100 in the past year with a 28.5 per cent return.

“The question I always ask myself is: am I invested in a solid company with a solid-enough position that it could earn excess profits and report strong dividends?” says Rhodes.

He refuses to screen companies according to the size of current payouts as he thinks lower yields are attractive. “High-dividend yields can be precarious,” he says. “If you’re looking to invest over one to two years, growth is extremely important. If a company is expanding, a 4 per cent yield will catch up to a 6 per cent dividend yield quite quickly.”

His fund’s largest holdings include Methanex, the Canadian methanol producer, Banco de Brasil, Chubb, the US insurer, HSBC, Telefónica, the Spanish telecommunications group, and Fosters, the brewery. About 45 per cent of the fund is invested in US and Canadian companies. Another 10 per cent is in Latin America – where Brazil is a favoured market – 20 per cent in Europe, and 8 per cent in Australia.

Newton’s Global Higher Income fund, which yields 4.63 per cent on a historic basis, has a 9.47 per cent stake in the US tobacco company Reynolds American, a 3.26 per cent in Vodafone, and a 3 per cent stake in Deutsche Telekom.

However, while more managers are now offering global equity income funds, there is still some reluctance to buy on the part of UK investors. More than £49bn in assets is still held in UK equity income funds, according to recent figures from the Investment Management Association, while just £1.8bn is invested in global equity income funds.

Advisers say there is concern that the discipline of meeting quarterly payments will test some overseas companies’ mettle. In Asia, for example, M&G’s Rhodes notes that dividends tend to rise or fall with a company’s profits. “When profits go up, dividends do as well and when profits fall, so do dividends. So you have to be very careful not get sucked in,” he says.

Another downside to seeking yield abroad is the withholding taxes often imposed on dividend payments by foreign governments. But Rhodes points out that in most cases, the tax rate is no higher than 15 per cent, thanks to tax treaties.

Leigh Harrison, head of equities with Threadneedle, is quick to argue that a number of UK companies are emerging from the recession in good shape. Glaxo Smith Kline, BAT, Imperial Tobacco, and BT, for example, all offer prospective yields higher than 4.49per cent.