It pays dividends to go global

The much-discussed hunt for yield continues in line with the relentless squeeze on UK income. Investors face a challenging picture.

Since 2007, average yearly council taxes are up 11 per cent; household electricity bills are up 30 per cent; the annual costs of running the family car and paying the family food bill are both up a staggering 60 per cent. And thanks to record low interest rates, the value of £10,000 invested in cash 10 years ago would have lagged well behind the rate of inflation, leading to a loss in real terms.

That last point is key for pension savers, or indeed anyone seeking to harvest income from their investments or concerned about maintaining their purchasing power in retirement. Thanks to years of low interest rates and rising income needs, many people face a real danger of falling short of their long-term financial goals, or quite simply running out of money as they age. Income-seeking investors have been forced to look beyond traditional sources to make up the shortfall.

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A traditional favourite for investors seeking both capital appreciation and reliable income has long been UK equity income and the many funds available in that sector. However, there is reason to be concerned that even this trusty stalwart is and will be a less than viable source of income. In fact, figures suggest it is a shrinking and potentially volatile asset class.

Dividend growth among UK businesses is the slowest in more than three years as companies struggle with a relatively strong pound and a mediocre global economy. Excluding special dividends, the latest UK Dividend Monitor report by Capita Asset Services showed just a 1.4 per cent annual increase to £79.1bn paid out in 2014 – a decline in real terms (data as of January 2015).

What is more, concentration risk means that it has become dangerous for investors to rely too heavily on UK dividend income. In fact, in the fourth quarter of 2014, just three UK companies – Shell, BP and HSBC – made up three fifths of all UK dividends paid out. Obviously, it is news to no one that UK dividends are substantially reliant on a small handful of big companies, but what may be more timely is that two of those companies rely for their income on a commodity product that more than halved in price by the end of 2014. If we look back at recent history, BP also provided a graphic example of the pitfalls of this situation in 2010, when the suspension of its dividend alone caused a drop of nearly 10 per cent in the total UK dividends paid.

As shown in the illustration below, the vast majority of total UK dividends (more than 60 per cent) come from a small handful of companies, meaning that a UK equity income investor might inadvertently be overly dependent on individual company dividend payouts rather than having a diversified source of income.