What next for equity income?

  • To understand the factors that have driven equity market performance in recent years
  • To describe the challenges facing equity income managers in the years ahead
  • To explain how monetary policy impacts equity income investing
  • To understand the factors that have driven equity market performance in recent years
  • To describe the challenges facing equity income managers in the years ahead
  • To explain how monetary policy impacts equity income investing
Supported by
Vanguard
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CPD
Approx.30min
pfs-logo
cisi-logo
CPD
Approx.30min
Supported by
Vanguard
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Supported by
Vanguard
pfs-logo
cisi-logo
CPD
Approx.30min
What next for equity income?

For most of the past decade, equity investors with income as their priority have faced the dilemma that most of the stocks that performed best, including many in the technology space, paid little in the way of dividends.

At the same time, many of the traditional income-paying sectors, such as in the commodities and banks, performed relatively poorly during that period. 

So equity investors faced the dilemma of buying income stocks and probably underperforming relative to the index, or buying technology stocks and struggling to achieve a decent yield. 

Bob Tannahill, investment manager at Ravenscroft, says that the investment landscape could be described as Tina (there is no alternative), as bonds yielded nothing, while the best-performing equities were those that have no yield. 

For clients with longer-term time horizons, we would say they shouldn’t try to reach for yield.Bob Tannahill, Ravenscroft

This year reversed that trend, with technology stocks performing poorly and cash pouring into commodities. 

But with the market change came a new challenge, as much higher inflation depreciated the spending power of the income generated from equities.

And with that higher inflation came fear among market participants about the health of the global economy. And the rise of such risk off sentiment has caused a debate among market participants around whether having material overweights to economically sensitive stocks such as commodities and financials is prudent. 

Tannahill says this poses an additional challenge for advisers and wealth managers, as they have to explain why a portfolio can provide a yield superior to cash, at a time when there is a “lag” between portfolios being able to distribute the cash to clients and the present inflation rate.

 

He says: “Clients can see they can get a decent level of interest in terms of cash at the bank, but when they look at some funds, they see a yield not that high. That’s because it takes time for the distribution from funds to catch up with where yields are.

"And to be honest, a client with a short-term time horizon, we would say to them, ‘if you can get 2.5 per cent at the bank, locked in for a year, then it's probably best to do that right now, and come back to us in a year when that has changed. Rates and inflation are likely to be lower in a year from now.

"For clients with longer-term time horizons, we would say they shouldn’t try to reach for yield. We think a yield of 3.5 per cent is OK, as long as it is a yield that’s growing and there is capital gains as well.” 

More than the money?

But for Andy Surrey, senior national development manager at Vanguard, income-paying stocks have a role in portfolios that goes beyond simply providing a dividend.

He says: “While capital gains get most of the attention in equity investing, dividends generate multiple benefits. Firstly, dividends provide a regular and dependable income stream for equity holders. While capital gains are influenced by market directionality, dividends are usually paid whether the broad market goes up or down.

"That dependable income stream together with the upside potential of price appreciation provide a valuable diversification benefit to income-seeking investors, especially during periods when interest rates are low or rising. Dividend investing, however, is not merely an income diversifier, it is also a source of growth that has the potential to keep up with inflation.

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