Investors need to be made aware of the high dividend risk in UK Equity Income funds, following warnings from industry experts of another BP-style crisis.
Their comments come in light of a recent FE Trustnet
study that found a number of funds in the UK Equity Income sector rely on a single company to deliver 10 per cent of their overall income.
"These managers are obviously confident that the companies aren’t going to cut their dividend, but this is still a big risk when one company means so much to the yield," said Richard Troue, analyst at Hargreaves Lansdown.
"Any forecasts don’t take into account unforeseen risks – no-one saw the BP crisis happening."
Vodafone, the most popular stock with UK equity managers, and the highest yielding with a dividend of 5.3 per cent, appears in the top-10 holdings of 73 per cent of the funds in the IMA UK Equity Income sector.
Forty-four of these funds have more than a 5 per cent weight and, given that very few are yielding more than 5 per cent, the risks are clear.
The BlackRock UK Income
portfolio, for example, is currently yielding 4.22 per cent. Manager Nick McLeod-Clarke
has 9.7 per cent of his portfolio invested in Vodafone, which means that if he bought the stock at the current price, its yield would account for 12 per cent of the fund’s total income.
"This isn’t an exact science because this is only based on the current price of Vodafone and we don’t know what the manager bought the stock at; however, assuming they bought Vodafone lower than what it is now, this figure actually underestimates the risk," explained Rob Gleeson, head of research at FE.
Top-10 holdings of BlackRock UK Income
Source: FE Analytics
|% of fund
|Royal Dutch Shell
|British American Tobacco
The fund also has an 8.6 per cent weighting to Royal Dutch Shell which, with a current dividend of 4.81 per cent, accounts for 9.8 per cent of its overall yield.
This means that two companies account for more than 20 per cent of BlackRock UK Income's yield.
The fund is not alone, however. There are 34 UK Equity Income portfolios that have more than a 5 per cent weighting to both Vodafone and GlaxoSmithKline, four of which have a yield of less than 4 per cent, and 24 of which are yielding less than 5 per cent.
These include Neil Woodford’s
£12bn Invesco Perpetual High Income
fund, which has a yield of 3.95 per cent and 8.36 per cent invested in GlaxoSmithKline – a company that is currently yielding 4.8 per cent. This means that Glaxo’s dividend accounts for more than 10 per cent of the fund’s yield.
Invesco Perpetual refused to comment on the matter.
Troue suggests that more needs to be done to make investors aware of the high dividend risk in UK Equity Income funds.
"I don’t think the average retail investor would have any idea of these risks," he said. "Perhaps there needs to be more emphasis on managers making these risks known to investors, or on their factsheets."
Gleeson added: "I think a lot of investors would be surprised if they knew this, particularly given what happened with BP."
Speaking to FE Trustnet
, McLeod-Clarke defended BlackRock UK Income’s process, insisting that the fund’s high-conviction approach is a strength rather than a weakness.
"We run a concentrated portfolio, typically of 40 stocks," he explained.
"If the portfolio was overly diversified it would be more susceptible to dividend cuts. The fact we are more focused means we are able to concentrate on the companies that will help us avoid cuts."
The manager was also keen to point out the fund’s stellar dividend record. It has grown its yield every year since inception 27 years ago – longer than any other fund in the UK Equity Income sector.
In the total return tables, BlackRock UK Income has outperformed its FTSE All Share benchmark over five- and 10-year periods, but fallen marginally short over three. Since taking over as manager of the portfolio in February 2007, McLeod-Clarke has outperformed the index by 3.51 per cent.
Performance of fund vs sector and index over 5-yrs
Source: FE Analytics
Adam Avigdori joined McLeod-Clarke as co-manager in November 2009.
Kerry Nelson, managing director of Nexus IFA, says she looks to diversify the risks associated with UK Equity Income by holding other types of income funds.
"I look to counterbalance this with a global equity income fund or a smaller cap income fund, which have become more popular in the last 12 months or so."
"Some of the really big funds out there are forced to have a big stake in these types of companies to prop up their yield."
"For this reason, I’d balance an Invesco Perpetual High Income and Rathbone Income
with a Marlborough Multi Cap Income
and Trojan Income
, which are a little smaller."
"In the Global sector, I’d go for Newton Global Higher Income
or JPM Global Equity Income
," she finished.