The UK market is under threat from large companies increasingly using debt to pay their dividends, according to Standard Life Investment’s Thomas Moore.
Speaking to FTAdviser, Mr Moore – who runs Standard Life’s £1.2bn UK Equity Income fund – said investors should be “wary” of many large UK companies using debt to maintain a level of dividend.
“Over the past five years there has been a trend of weakening earnings, so the dividend cover for some of the large companies has become tighter and tighter,” he said.
“Large cap dividends are under pressure, which is now coming to a head.”
Mr Moore, who also runs Standard Life’s £174m Equity Income trust, claimed some equity income vehicles are having difficulty maintaining the sector requirements set out by the Investment Association, partly because of flat and falling dividends.
He said he has avoided some larger companies with tight dividend cover for this reason, opting for small and mid cap stocks instead.
Since taking over the trust in 2011, Mr Moore has signficantly reduced its weighting towards FTSE 100 companies, taking it down from 70 per cent to 30 per cent.
His fund has around 37 per cent invested in large cap stocks.
“Debt markets have been easily accessible to large companies,” he said, adding smaller companies have tended not to rely on debt markets to pay off dividends.
“I think over time paying the dividend with debt will be harder to sustain, which will become a danger at the market level.”
The Standard Life fund manager said the sectors suffering the most are food retailers, utilities, mining, banks, and industrials, but claimed this is likely to spread further.
Mr Moore also pointed to pharmaceutical and oil companies, which he said are often reliant on a stream of future earnings and are not necessarily generating the cash they need this year to cover their dividends.
“I always feel I have to be cynical as a fund manager towards companies that promise things tomorrow because I’d rather see those come through today.
“In my view the high dividend yields on offer don’t compensate for the risk of disappointing cash flows later, or the risk of something external happening which could knock the dividends.”
Mr Moore said he selects stocks which have control over their dividend growth and have balance sheets that are in good shape.
He said: “We have got revenue reserves which are at record levels, so we have got something tucked away if things get tougher.”
|Top Ten Holdings In Standard Life Investment UK Equity Income Unconstrained Fund|
|1. BT 4.2%|
|2. Vodafone 3.5%|
|3. Sage 3.3%|
|4. Aviva 3.1%|
|5. L&G 2.9%|
|6. RELX Group 2.7%|
|7. Close Brothers 2.5%|
|8. Saga Group 2.5%|
|9. National Express 2.5%|
|10. Prudential 2.4%|
Alex Reynolds, financial adviser with London-based Advies Private Clients, said he agreed with Mr Moore’s concern about companies using debt to maintain dividends.