Mid-caps paid more in dividends than large-caps in the third quarter of 2016, according to the latest data from Capita, despite a significant boost from a plummeting pound and fears over the UK economy following the Brexit vote. 
The hunt for yield has continued to play an important role in 2016, with zero and negative interest rate policies pushing bond yields ever lower and forcing income-focused investors into other asset classes.
With property underperforming in part thanks to concerns over house prices in the UK following the vote on 23 June, investors have looked to equities, particularly the larger, more defensive stocks found in the FTSE 100.
As the below graph shows, over the year-so-far, government bonds have risen 11.34 per cent and in many cases are now offering negative real yields.
Performance of indices in 2016
Source: FE Analytics
As a result, investors appear to have continued to buy into more defensive stocks, with a premium placed on those offering a dividend, meaning the FTSE 100 has now gained 16.11 per cent in 2016, despite suffering a post-Brexit fall.
As JOHCM’s Christopher Lees said earlier this month, this trend of rising dividends and falling bond yields has led to a change in the dynamic that has existed for the last 10 years.
He said: “It’s a strange world we live in where, year-to-date, people have been buying equities for yield and buying bonds for capital appreciation. Equities win the least ugly competition and that’s what we’re faced with at the moment.”
According to research from Capita, overall UK dividends rose 1.6 per cent in the third quarter of this year to £24.9bn and was up 2.6 per cent when stripping out special dividends.
This was boosted particularly by the impact of the dramatic fall in the pound, with the dollar up 20 per cent and the euro gaining 22.35 per cent on the UK currency in 2016.
With many of the largest constituents of the FTSE 100, such as Royal Dutch Shell and HSBC, which combined make up 15.14 per cent of the index, reporting in dollars, dividends in certain parts of the market have risen substantially.
Capita said: “The most significant immediate effect was the devaluation of the pound, which continues to trade at multi-year lows against the dollar and the euro.
“Roughly two-fifths of UK dividends are declared in those currencies, meaning their translated value is higher in sterling terms.
Performance of sterling vs dollar and euro in 2016
Source: FE Analytics
“The sharp devaluation of the pound since the vote to leave the European Union made the biggest contribution to the better-than expected figures.”
Indeed, the biggest dividend payer in the quarter was Shell, which returned £2.8bn to investors and accounts for slightly more than £1 in every £8 paid out by UK-listed companies.
This has negated some £2.2bn of dividend cuts, mainly in the resources sector, with large cuts from the likes of Glencore, BHP Billiton, Rio Tinto and Anglo American impacting returns.
“Collectively their pay-outs were £1.9bn or 68 per cent lower year-on-year, despite a 20 per cent boost from the weaker pound,” Capita said.
“[However,] after briefly outpacing mid-cap 250 dividends in the second quarter, although only for technical reasons, the top 100 reverted to its pattern of the last two years, and failed to keep up with its smaller peers during the third quarter.”
While the currency impact had a larger effect on exporters and more internationally-facing companies, almost all the aforementioned dividends cuts were in the FTSE 100.
“Mid-cap dividends were 4.9 per cent higher year-on-year at £2.7bn, though after lower special dividends were taken into account, underlying growth was an even more impressive 11.5 per cent,” Capita said.
“The mid-caps have been far more insulated from the succession of negative trends to hit the profits of the top 100.
“These have included weak commodity and oil prices, difficulties in the banking sector, and price wars in the grocery industry. Mid-cap profits have outperformed, and that is enabling them to grow their dividends consistently faster.”
Growth of FTSE 100 vs mid-caps quarter-on-quarter since Q1 2009
Source: Capita UK Dividend Monitor
As the above graph shows, last quarter the FTSE 100 grew dividends faster than the FTSE 250, in part thanks to a number of special dividends and the contribution of the final pay-out from SABMiller, but this has returned to the norm in the third quarter, with mid-caps outpacing their larger rivals.
Last month, Michael Clark, manager of the Fidelity Moneybuilder Dividend and Enhanced Income funds, said he had been upping his exposure to mid-caps as the market stabilised following the Brexit vote.
Traditionally, mid-caps are seen as a pure-play on a country’s economy, with most domestically-focused having little exposure to outside markets.
With expected underperformance of the UK economy yet to kick in, Clark said: “One can invest in UK-based companies and not see it as a big problem.”
Overall, Capita has upped its forecast for the year, by £2.2bn to more than £5.6bn by the end of 2016 thanks to the fall in sterling.
This “unusually large move for this late in the year” reflects an additional £1.4bn in exchange rate gains and allows for more special dividends than expected.
However, the research firm said: “In truth, the picture is rather disappointing.”
Stripping out the positive effect of the exchange rate windfall, and the negative impact of high profile dividend cuts, dividends were actually 0.1 per cent lower year-on-year in the third quarter.
“Weak profitability among the UK’s largest companies, including large losses for some, as well as growing pension deficits, has made it difficult for them to increase what they pay to their shareholders,” Capita said.
“The dominance of those huge multinationals is, however, obscuring more positive news from those lower down the rankings.”