Income investors witnessing the current erosion of dividend payouts should not despair, say fund managers, as the search for stable yields from income stocks and funds is likely to be more fruitful from January.
In spite of the current spate of gloomy news from the income sector, some fund managers and advisers believe the worst of the dividend cuts are now over and the outlook for income funds – which can offer a 4.5 to 5 per cent yield – is about to improve.
“Income stocks look very good value when interest rates are 0.5 per cent and 10- year gilts yield 3.75 per cent,” said Chris White, Threadneedle’s head of income funds. “As the stock market rally broadens out and moves away from some of the more cyclical areas, I think that it will alight on high-yielding equity income stocks.”
Echoing White’s views, Adrian Frost, manager of the Artemis Income fund, predicted dividends would rise as companies begin to generate cash and look for ways to distribute it.
“For many companies, it was as much the state of their balance sheets during the credit shock as their profit and loss accounts that prompted dividend cuts,” Frost pointed out. “Since then, many have refinanced via equity and bond markets. With minimal dividends to service, cash generation is beginning to build. Then what? Increase or restore the dividend? Maybe even a share buyback? This will begin to ease the problem for the income manager – that dividends are concentrated in a small number of large companies.”
In the past 12 months, more than a quarter of FTSE 100 companies offering quarterly or half-yearly cash dividends have either reduced or scrapped them due to falling profits.
Income fund managers have followed suit.
The quarterly or half-yearly dividends paid by more than three quarters of UK equity income funds in the last month have been cut, according to the latest report from Dennehy Weller & Co, the advisory firm. Almost 40 per cent of these funds have seen their dividends reduced by more than 20 per cent.
But there is hope on several fronts. The payouts offered by funds that focus on markets outside the UK are holding up. This suggests that income investors should devote more attention to scouring Asian and European markets. Newton’s Asian Income fund’s 5.18 per cent quarterly dividend yield is almost 10 per cent up from last year, for example, while the 5.14 per cent quarterly payout on the Sarasin International Equity Income fund marks a 12.46 per cent rise on last year.
On the list of companies that are continuing to increase their payouts are AstraZeneca, Glaxo, BAT Industries and Royal Dutch Shell, which all yield more than 4 per cent. Another sought after income stock is Vodafone. Its interim dividend rose from 2.57p to 2.66p.
Frost at Artemis dubbed these stocks “chuggers” thanks to their steady performance. He believes these companies will continue to report dividend increases of 5 to 10 per cent in the coming years as they regain their ability to generate cash.
He warned, however, that dividends denominated in US dollars as well as oil stocks could buckle under pressure if the dollar or the oil price weakens.
The sectors bearing the brunt of recent cuts include banks, housebuilders, media companies and retailers. And while Nick Purves, a fund manager with Schroders, thinks profits will recover in these areas in two to four years, he was hesitant that dividends will turn around quickly. “Even if corporate profits recover, it’s unwise to expect that to be reflected in a big increase in dividends,” he said.
