Top funds in the UK equity income space

Top funds in the UK equity income space

Where does the nation stand on the UK’s post-Brexit prospects? With the scheduled departure date of March 29 drawing ever closer, the question is no less divisive than it was back in 2016. But the Brexit debate has proved less polarising when it comes to the behaviour of those investing in domestic equities.

Domestic shares have been heavily discounted amid Brexit-related uncertainty, with UK investors also fleeing funds operating in this market. The Investment Association’s UK All Companies sector has seen retail investors withdraw a net £3.9bn in the year to the end of November 2018 alone. While some may view UK equities as a steal, they look to be in the minority for now.

That said, one particular area where the appeal of holding UK stocks looks unequivocally more attractive is equity income.

Income funds focusing on the UK market have not escaped the adverse sentiment of recent times. Retail investors took out a net £1.2bn from the IA’s UK Equity Income sector in the 12 months to the end of November 2018, and every fund in the sector posted a negative return last year. But the UK market’s attraction for dividend investors – long one of its strengths – has been boosted further by the fact the FTSE All-Share index now yields even more than usual as a result of recent market volatility.

For those value-minded investors with money to deploy, there are now income bargains to be found: the FTSE 100, home to many of the big dividend payers, dropped by 7 per cent in 2018. These losses can be good news for a bargain hunter; share price falls mean dividend payouts have increased for those willing to buy in now.

As of the end of December, for example, the FTSE All-Share yielded 4.5 per cent, with the FTSE 100 yielding 4.7 per cent. The latter has a forecast yield of 4.9 per cent for this year, with the biggest single payer, Taylor Wimpey, targeting an eye-watering 13 per cent payout. 

No free lunch

Investors should be reminded of the risks before blindly ploughing in. In a time of market jitters, stocks could easily fall further, causing difficulty for clients relying on a portfolio for income. At the same time, the usual concerns remain around whether the high dividends seen in the UK market are sustainable. 

Russ Mould, investment director at AJ Bell, notes that dividend cover – the ratio of a company’s net profits to its payouts – came in at 1.21 times for the FTSE 100’s 10 highest yielders as of mid-December, a figure he described as “lower than ideal”. This suggests dividends face the risk of being slashed, or even cancelled altogether.

The challenges don’t end there. As discussed, a major unknown quantity also comes in the form of Brexit, which could dampen the prospects for UK-focused companies. 

Income investors arguably have some protection against these difficulties, given many of the bigger dividend payers are international companies with operations beyond the UK. But in the short term at least, these shares could be affected by developments in the Brexit process and their influence on the value of sterling.