Income investors face further cuts to their dividends following proposals by Ofwat to cut household water bills by 4 per cent, analysts have warned.

On Thursday, the water regulator announced a five-year pricing plan that will see the average household water bill fall by £14, to £330, by 2015. But shareholders in UK water companies are likely to see their dividend payouts reduced, as a result.

“Ofwat’s announcement is good news for consumers, but not so great for investors,” said Adrian Lowcock, senior investment adviser at Bestinvest. “The water companies will be allowed to make a return on investment of 4.5 per cent, which should enable them to maintain their dividends, but there is concern that the ruling could force cuts to payouts in the future.”

Some water companies will be more adversely affected than others. By the end of the five year period, Thames Water‘s bills will be 15 per cent lower than the level the company had requested from the regulator, and Severn Trent’s will be 12 per cent lower.

“At this early stage, the proposals appear to be far more negative for the more inefficient companies like United Utilities, with the more efficient companies, Pennon and Northumbrian Water faring better,” said Elaine Coverley, utilities analyst at Brewin Dolphin. “United faces the toughest price cut with a proposed -6.3 percent adjustment in 2010/11, while Northumbrian, which decided to abate price increases for customers in the current review period, has been rewarded with an average price adjustment of +2.8 per cent over the five years.”

Shares in the major water companies fell on the announcement, with United Utilities down as much as 5.5 per cent to 475p in early trading, and Severn Trent down 4.3 per cent, to £10.65.

Dividend cuts will leave private investors – and equity income fund managers – with fewer high-yielding shares to choose from. “With the equity income sector already reeling from the loss of dividends from the banks – the biggest sector to payout dividends previously – losing even a proportion of dividends from another major contributor is a big blow,” said Lowcock.

Advisers suggested that investors needing to protect their income streams should diversify into other asset classes, such as corporate bonds. Bestinvest’s fund recommendations for income seekers are Ignis Argonaut European Income, Legal & General Dynamic Bond and Threadneedle High Yield Bond.

Ofwat sets limits on how much UK water and sewerage companies can charge once every five years, based on business plans submitted by the companies. According to Ofwat chief executive Regina Finn, the new plans will allow water companies to invest £21bn improving services between 2010 and 2015. Pricing levels will be finalised in November, following consultation on the proposals.

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