However, in an article earlier this morning Colin Morton, manager of the four-crown rated Franklin UK Equity Income fund, warned that four of the most commonly held UK income stocks – BP, Royal Dutch Shell, GlaxoSmithKline and Vodafone – are facing significant risks relating to their dividends.
In the case of the two oil majors, he warned that they will have to start paying their dividend out of their balance sheets if the oil price were to remain low for any length of time, while he said GlaxoSmithKline will be consuming all of its cash flow to pay the dividend if the business doesn’t start improving operationally.
For Vodafone, he warned that due to large-scale investment on the part of the management, its dividend won’t be covered until 2017.
“What is scary about those four companies – BP, Shell, GlaxoSmithKline and Vodafone – is when you put them together, they make up around 25 to 30 per cent of all the dividends the UK market pays,” Morton said.
“We [UK investors] basically have 30 per cent of our pension funds’ dividend payments in these four companies which, arguably, have dividends that are challenged.”
It is clear that these four stocks, along with HSBC, are hugely important to UK investors.
Source: FE Analytics
According to FE Analytics, 66.6 per cent of IA UK Equity Income funds hold GlaxoSmithKline in their top 10, 58.3 per cent hold Shell, 47.6 per cent have BP and 46.4 per cent have high exposure to Vodafone.
Our data shows that 23.4 per cent of funds in the sector hold all four stocks in their top 10, while 45.2 per cent hold at least three. What is probably even more eye-catching, though, is that just 17.85 per cent of funds hold none of those four mega-caps.
Given their size in the index, it isn’t too surprising that these four are popular holdings with UK managers. Nevertheless, using data from FE Analytics, we look at the funds which have the highest proportion of their income generated from these stocks.
It is an easy calculation to make as you take the amount the stock makes up of a fund, times that figure by the stock’s dividend yield and then divide it by the fund’s yield.
As mentioned earlier, pharmaceutical giant GlaxoSmithKline is one of the most popular holdings in the sector as 56 of the 84 direct IA UK Equity Income funds – therefore excluding fund of funds – hold it in their top 10.
It has a number of notable backers and one of the best examples is FE Alpha Manager Neil Woodford, who had a high weighting to FTSE 100 pharma in his Invesco Perpetual funds and currently holds 6.3 per cent of his £5bn CF Woodford Equity Income fund in the stock.
Data from FE Analytics suggests that 8.7 per cent of Woodford’s total income comes from GlaxoSmithKline.
That isn’t the highest figure in the sector, however, as the table below shows other well-known funds such as Schroder Income, Evenlode Income and Threadneedle UK Equity Income derive more of their income from Glaxo.
Source: FE Analytics
While Morton told FE Trustnet that BP and Shell had entered this period of lower oil prices in good financial strength, he was contemplating selling the two holdings as he was concerned their future dividend payments wouldn’t be safe if the price of oil stayed below $75 a barrel for any length of time.
The positive for investors is that Shell hasn’t cut its dividend since the Second World War and won’t want to change that any time soon. It’s a different story with BP, as thanks to a giant oil spill in the Gulf of Mexico in 2010 it had to cut, which severely hurt its share price.
Performance of stock versus index in 2010
Source: FE Analytics
JPM UK Higher Income is one of the funds which generates the highest proportion of its income from Shell at 9.4 per cent, while Jupiter Income Trust and Insight Equity Income garner 9 per cent of their dividends from BP.
Clive Beagles and James Lowen, co-managers of the five-crown rated JOHCM UK Equity Income fund, are another example of managers who count the two oil majors in their top 10.
The £2.7bn fund has 11.77 per cent of its total assets across BP and Shell, but derives a much larger 16.2 per cent of its total income from the two stocks.
Vodafone is the least popular with UK income managers of the four stocks mentioned as 39 hold it in their top 10. Also, unlike with the three other holdings, UK managers don’t tend to be overly concentrated in the telecom giant.
As a result of that, and as it has a lower dividend yield than Glaxo, BP and Shell, the funds with the highest dividend risk in Vodafone only derive around 4 per cent of their income from the stock. These include the Vanguard FTSE UK Equity Income Index, Old Mutual UK Equity Income and F&C Responsible Income funds.
As mentioned early, 23.8 per cent of the sector – or 20 funds in total – count all four stocks as top 10 holdings.
If worst came to worst and all four did cut over the coming years, one fund which is highly exposed at this point in time is HSBC Income. According to FE Analytics, the fund generates 12.9 per cent of its income from Shell, 9.4 per cent from BP, 8.8 per cent from Glaxo and 4.2 per cent from Vodafone.
That means that, overall, the fund generates 35.3 per cent of its dividend from those four companies.
Source: FE Analytics
Other well-known funds which generate a large proportion of their income from Glaxo, BP, Shell and Vodafone include R&M UK Equity Income, Schroder UK Alpha Income and AXA Framlington Monthly Income.