Finding high-yielding – and even more importantly, sustainable – assets has become more important in the current economic climate.
Even today, the Bank of England discussed the possibility of negative interest rates which would deal an even bigger blow to savers.
With investment grade bonds yielding next to nothing, more and more investors are turning to dividend-paying equities in the search for income.
However, it is not just about locating high-yielding companies; investors need to be confident that these stocks are able to maintain their dividend, or better still increase it.
Richard Hunter, head of equities at Hargreaves Lansdown, says that a company’s dividend cover is the most vital component to the sustainability of its yield.
Highest-yielding stocks in the FTSE: 1 to 5
Source: FE Analytics
|RSA Insurance Group
"In theory, if a company’s dividend cover is under 1-times earnings, then they are effectively paying out their dividend from last year’s earnings – which obviously means their yields could prove difficult to maintain," he explained.
Resolution – 7.83% yield
UK insurer Resolution is the highest-yielding company in the FTSE, but Hunter is not convinced this will be the case for much longer.
"Resolution is an awkward one; there has been a lot of talk about them having to cut their dividend – especially as they have a dividend cover of 0.8 times," he said.
"However, the current yield is around 7.5 per cent and they have a projected yield of 8.2 per cent – this suggests they are looking to increase the dividend, more than anything."
According to FE Analytics
, despite the fact Resolution is currently the highest-yielding company in the FTSE, only 23 funds in the IMA universe count it as a top-10 holding. This includes Schroder Income Maximiser
The majority of funds that hold it are growth orientated – for example, FE Alpha Manager Martin Walker’s Invesco Perpetual UK Growth
fund has a 4.21 per cent weighting to Resolution.
Aviva – 7.27% yield
Hunter is even less optimistic about Aviva’s 7.27 per cent yield.
"I think it is unlikely Aviva will be able to maintain their dividend, but we will know soon enough as their annual earnings report is due a week tomorrow," he said.
Twenty-four funds count the insurer as a top-10 holding. FE Alpha Managers Andrew C Green
and Julie Dean
both have large weightings in their GAM UK Diversified and Cazenove UK Opportunities
ICAP – 6.53% yield
"ICAP’s projected dividend is flat to what it currently is, so that certainly asks the question whether or not it is sustainable," Hunter continued.
"However, it does have a 1.6-times dividend cover, which suggests it could be sustainable."
Guinness Global Equity Income
is the only fund in the IMA universe to hold the fund in its top-10.
RSA – 6.06% yield
Hunter says RSA’s chance of maintaining its 6.06 per cent yield is zero, as the company has already cut its forecast.
"The yield has already been cut due to a drop in performance last year – and the share price took a hammering because of it. It has cut its yield to 5.5 per cent, which is still quite punchy in a world of very low interest rates," he said.
All in all, 21 funds hold RSA in their top-10. These include FE Alpha Manager Leigh Harrison’s Threadneedle UK Equity Income
, FE Alpha Manager Crispin Odey’s CF Odey Opus
, and Artemis High Income
– which is run by FE Alpha Managers Adrian Frost
and Adrian Gosden
Vodafone – 5.94% yield
"Vodafone has a good dividend cover and is projecting a yield increase from 5.9 per cent to 6.1 per cent, so there is no reason to suggest that they would walk away from their dividends," said Hunter.
"However, the question is whether they can repeat their special one-off dividend – which came from their 45 per cent holding in Verizon."
More than 10 per cent of funds in the IMA universe hold Vodafone in their top-10, making it one of the most popular stocks overall.
FE Alpha Manager Robin Hepworth’s Ecclesiastical Higher Income
and Francis Brooke’s Trojan Income
are two of 338 funds that have a high weighting to the telecoms company.
Highest-yielding stocks in the FTSE: 5 to 10
Source: FE Analytics
|Scottish & Southern Energy
|Royal Dutch Shell
Graham Toone (pictured)
, head of research at AFH Wealth Management, is less strict than Hunter when it comes to determining how sustainable a yield is.
"We like companies that have at least 1.5-times dividend cover, but prefer to have that closer to 2-times," he said.
"Anything lower than that means the company has to dip into its savings in order to pay their shareholders – which is not ideal."
Scottish & Southern Energy – 6.67% yield
"We are comfortable with Scottish Southern Energy and it is one we buy," said Toone.
"Although the dividend isn’t covered as well as we would like – just 1.2-times – we feel the business will be able to deal with this level."
FE data shows that no open-ended funds count Scottish & Southern Energy as a top-10 holding.
BAE Systems – 5.61% yield
"BAE Systems is 2-times covered so I think that is certainly a level of dividend yield they can keep," said Toone.
FE Alpha Manager Neil Woodford
holds BAE Systems in the top-10 holdings of his Invesco Perpetual High Income
, Invesco Perpetual Income
and SJP High Income funds.
The other 28 funds that count the defence and aerospace company as a top-10 holding include the five crown-rated Rathbone Blue Chip Income & Growth
and Majedie UK Equity
National Grid – 5.55% yield
"National Grid – like Scottish Southern Energy – is borderline," said Toone. "It is yielding 5.5 per cent but its dividend cover is 1.2 times, which is a bit more concerning.
"However this one isn’t a stock we are buying at the moment."
Trojan Income is one of 21 funds that count National Grid as a top-10 holding.
GlaxoSmithKline – 5.02% yield
Toone is confident about Glaxo’s ability to sustain its yield.
"GlaxoSmithKline is a popular income-generative holding and it is one we use," he said.
"Although it isn’t as well covered as people think – at 1.5-times earnings – I think that dividend is sustainable as it is a well-run company."
Seventy-two per cent of funds in the IMA UK Equity Income sector count Glaxo as a top-10 holding. Around 360 funds in the entire IMA universe have a high weighting to the pharmaceutical company.
Royal Dutch Shell – 4.96% yield
"Royal Dutch Shell’s dividend yield is well guarded – its dividend cover is at least 2-times earnings and it is a stock we like and use for our clients," Toone finished.
Royal Dutch Shell is another universally popular stock with fund managers.
All in all, 362 funds hold the energy company as a top-10 holding, including the likes of Liontrust Special Sits
, which is run by FE Alpha Managers Anthony Cross
and Julian Fosh