A combination of low interest rates and high inflation has pushed investors into high-yielding, defensive stocks. Couple this with record low government bond yields, a growth forecast of zero and persisting uncertainty in the eurozone and it’s no surprise that investors are tempted to double-up on their most successful dividend giants.
The latest FE Trustnet poll shows that three in 10 investors – 28 per cent – have more than half of their portfolio invested in equity income stocks.
In light of Ruffer’s Steve Russell's prediction earlier this week that equity income stocks are in danger of becoming a bubble, Adrian Lowcock, senior investment adviser at Bestinvest, says that investors need to careful they don’t over-expose themselves.
“Half of your portfolio in equity income stocks sounds a little on the high side to me,” he said. “Equity income is attractive at the moment but investors need to make sure they diversify – there is limited choice in the UK.”
“People shouldn’t exclude other asset classes. We’re really positive about the opportunities in high yield bonds and still recommend fixed income assets for more cautious investors.”
Lowcock says the figures are particularly worrying given that many investors only invest in the UK for their equity income exposure.
“The trend for dividends is spreading overseas and there are a number of funds focused on equity income strategies in the US, Asia, globally, and now in emerging markets as well,” he added.
While Hargreaves Lansdown’s Richard Troue believes that there is still plenty of opportunity in equity income stocks, he doesn't think investors should buy into the story at the expense of diversification.
“The risk of any asset class becoming inflated is something that investors always need to keep in the back of their mind,” he said. “With interest rates remaining low and inflation struggling to come down below the Bank of England's target then we’ve seen a growing appetite for high yielding shares. This has led some to speculate that high quality, defensive stocks are becoming overvalued.”
“I would suggest that exposure of more than 50 per cent to equity income stocks is too high for the majority of investors, especially if that exposure is concentrated in the biggest, FTSE dividend payers.”
Troue adds that it is probably too early for investors to be concerned of an equity income bubble, but thinks it's an area all investors should keep an eye on.
He commented: “In the short- and medium-term I don’t see interest rates rising or government’s pursuing quantitative easing aggressively enough to bring about rapid inflation so we remain positive about high dividend stocks for their ability to provide an attractive and growing income to compensate for low growth in the economy and negative yields in other assets.”
Star manager Neil Woodford, agrees. Even against the backdrop of a potential break-up of the eurozone, the legendary investor – who runs more than £20bn of UK investors money across his Invesco Perpetual Income and High Income portfolios – says that cash-generative, high yielding companies have a long way to run.
“Ultimately, I am confident that my preference for investing in quality, dependable growth companies at attractive valuations will provide decent long-term returns for my portfolios,” he said in a recent blog.