Research from Capital Asset Services found that dividend growth was at its slowest in the second quarter of this year since 2010, with the exception of a “freak quarter” in 2013.
Paltry growth of just 1.2 per cent was blamed on falling payouts from the biggest FTSE 100 firms. The UK’s biggest 15 firms, which account for 61 per cent of dividends and are hugely popular with UK income fund managers, saw negative growth over the three month period.
William Meadon, manager of the JPM Claverhouse IT, thinks that the dividend environment will continue to be difficult for UK investors.
He says he is relieved that he is able to draw on income reserves – a tactic open-ended managers are unable to use – as it will enable him to keep increasing his trust’s dividend.“In the second quarter of this year, dividend growth has been at its lowest for a number of years,” said Meadon (pictured).
“Forty per cent of the FTSE 100 pays out dividends in dollars, and many are under pressure because of the strength of sterling. If this continues, many could be in trouble. Special dividends also aren’t what they are and aren’t dependable.”
“The dividend environment has become a lot more challenging, and I think those with dividend reserves are in a good position as a result.”
“On a not too bearish outlook, I think there is a strong chance dividend growth could be negative this year. The reporting season has been mixed, and we’re in the longest continuous bull market for many a year.”
“There’s a lot of uncertainty about, and earnings are not coming through to meet the re-rating we saw last year and the year before.”
Meadon points out that Claverhouse and a number of its closed-ended counterparts were able to raise their dividend in 2010 in spite of holding BP, which infamously slashed its dividend in light of the Macondo disaster.
This, he says, illustrates the advantage of smoothing out dividends by using income reserves, and thinks this could come in handy for the rest of 2014.
Open-ended funds are forced to pay out all of the income they generate, meaning dividend cuts in stocks and sectors often forces them to cut their own dividend.
Claverhouse raised its dividend in 2013 for the 41st consecutive year. The payout was 3.4 per cent higher than 2012 – well in excess of inflation – and was covered by more than two times in income reserves.
Meadon says he is very confident that his trust will deliver inflation-busting dividend growth this year as a result.
Other UK Equity Income funds that have delivered consistent dividend growth include the City of London IT and Bankers IT, which have raised their income-pay-outs for 47 consecutive years.
Other trusts that were more than twice covered in 2013 include Nick Train’s Finsbury Growth & Income trust, Mark Barnett’s Perpetual Income & Growth trust and James Henderson’s Lowland IT.
Charles Cade (pictured), an analyst at Numis, says investing in a fund or trust with dividend growth at or in excess of inflation is particularly important to investors who rely on income from month-to-month or quarter-to-quarter.
“Whenever a period of pressure comes to the fore, trusts tend to deal with it better,” he said.“2009 and 2010 was a good example, when you had the banks and BP cutting their dividends. Trust came out of that period a lot better than funds.”
“A lot of people who invest in trusts rely on them to give them income. Total return is the all important thing, but being confident that a manager won’t cut a dividend without warning is very attractive puts trust at a significant advantage to funds.”
FE Alpha Manager David Coombs, head of fund of funds at Rathbones, says that equity income is “ideally suited” for a closed-ended structure, though himself focuses more on total return rather than dividend growth.
“If you are looking for dividend growth it’s a perfect structure. The pay-out isn’t diluted by inflows and a trust is much easier to manage because of that,” he said.
“Then you’ve also got the reserves that managers can draw on, but this is more important for someone relying on the income. I invest for total return rather than income.”
Poor results from GlaxoSmithKline yesterday has put yet more pressure on dividend paying companies. Profits were down 23 per cent in the second quarter, or 12 per cent if you exclude the impact of sterling.
This has prompted the company to cut its outlook for the full year, which now expects earnings growth to be "broadly similar to 2013".
The news saw the company’s share price fall around 5 per cent yesterday, and it’s down a further 0.5 per cent today at the time of writing.
Glaxo is one of the most popular stocks in the IMA universe, appearing in the top-10 of more than 350 funds.
Among its biggest admirers are FE Alpha Managers Neil Woodford, Leigh Harrison and Trojan Income, which all run UK Equity Income portfolios.
Meadon thinks mid-caps are likely to come under particularly pressure from an earnings and dividend-growth point of view, as well as sectors most exposed to the strengthening of sterling.
Mid-cap returns have faltered this year after a stellar 2012 and 2013.
Performance of index and stock in 2014
Source: FE Analytics
Capita reported that commodity and financial firms are most impacted by currency movements, and were in turn the worst performers from a dividend growth point of view in the second quarter of this year.
Justin Cooper, chief executive of Shareholder Solutions, says that the international focus of the UK stock market is a major headwind for income investors, though is more optimistic beyond the short-term.
“Given their size and contribution to the total amount paid out, income investors are a hostage to the fortunes of the very biggest listed companies,” he said.
“These global companies have felt the impact of a surging sterling and slowing momentum in the global economy, and struggled to maintain – let alone raise – the amount they are returning to investors. This has dragged down the performance of the whole market.”
“We should see a pick-up in 2015. It’s hard to imagine the currency continuing to detract from growth, and if the pound maintains its current level it will only have a small impact in the first half of next year.”
