Why investing in large caps pays dividends

This article is part of
Quest for the Holy Grail

Another major UK conglomerate, BP, notably suspended its dividend as part of its commitments to compensate victims of the Gulf oil spill in 2010. 

Jason Hollands, managing director at Tilney Bestinvest said: “Investors should be aware that even the larger blue chips can have set backs, and being invested in a large company does not guarantee the fruition of the targeted dividend level.

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“Most UK equity income contains the same four or five companies that have a good track record of achieving their dividend target, but there is certainly a case for investors to diversify their portfolio for dividends to include funds that solely invest in small and mid caps.”

Star fund manager Neil Woodford expressed disappointment over the performance of his £9.2bn flagship fund, which lagged behind the FTSE All Share. The fund returned just 3.4 per cent last year compared to 16.8 per cent by the index over the same period.

The fund's top 10 holdings boast a number of FTSE 100 dividend champions, but beyond this there is a greater focus on less well-known firms and even the presence of unquoted companies.

Mr Woodford pointed to a rally in commodity stocks as one of the main factors behind the fund’s performance.

Jason Broomer, head of investment at Square Mile Investment Consulting and Research, said: "Neil tends to have large core positions in larger companies typically in the pharmaceutical space, and between 20 and 25 small cap stocks that may not be income generating. Last year was not a good year for pharmaceuticals and small caps did not do so well." 

While small and mid caps generated a good cash levels with better dividend cover, they are at risk in the wake of the Brexit vote, conversely, depreciation in the British currency can help large-cap exporters.

Mr McDermott said: “Small and mid caps tend to be more domestic focused, which is set to come under some pressure with Brexit and thus will hurt these companies. I believe if you do your research thoroughly, there is still opportunity to get income in small and mid-cap companies.

The Unicorn UK Income fund, for example, which has a concentrated portfolio focused on the small and mid-cap space, ranks third in FE Analytics list of top-performing funds in the IA UK Equity Income sector over a five-year period.

Mr Broomer said: "Small and mid caps have done well, especially over a five-year period, but 2016 was a particularly difficult year for these stocks. Large companies tend to have numerous areas of business, so are able to recover from macro shocks unlike smaller businesses that do not have as many layers."