However, the amount of dividends paid out in Q1 2014 reached a hefty figure of £30.7bn, which is 118.5 per cent more than in Q1 last year. Nevertheless, the major driver of that increase was special dividends, most specifically Vodafone’s £15.9bn special payment; which is the largest in UK history.
Taking special dividends from Vodafone, Next and Easyjet out of the equation, underlying dividend growth in the UK was just 3.3 per cent compared to this time last year, which is the smallest increase in two years.
Capita attributes that lack lustre growth to the recent strength of sterling against the dollar, which combined with slower than expected growth within the UK’s largest dividend payers, is creating an issue for UK equity income investors.
For instance, Capita expects that the strong pound will mean that dividends in 2014 will be £3.5bn lower than they would have been if the average exchange rate had remained unchanged.
Justin Cooper, chief executive of shareholder solutions at Capita, says this means that UK equity income investor need to be a lot more selective in the hunt for dividends than they have been in the past.
“The size of Q1 dividends is extraordinary, but they depend heavily on just one company. Beneath the surface, the story is quite different,” Cooper said.
“The strengthening pound is a consequence of Britain’s recovery from the most damaging downturn in a century. But it is hitting income investors hard.”
“The British index is unique among the big developed stock markets for its dependence on global firms, and that means dollar earnings.”
“Those look much less attractive while the pound is soaring. It’s very unusual to see so many of our biggest companies struggling to increase what they return to investors.”
“This highlights a danger of index investing. If you want an income, you need to understand where growth is emerging, and select your sectors and companies carefully.”
Some of the worst hit sectors, according to the dividend monitor, were oil and mining.
A number of UK equity income managers have been adding to those areas of the market recently due to low valuations and good income characteristics.
According to FE Analytics, both the FTSE All Share Oil & Gas and FTSE All Share Mining indices have underperformed against the wider UK equity market over 12 months, for instance.
Performance of indices over 1yr
Source: FE Analytics
However, research from Capita shows that oil and mining companies’ dividends – which make up roughly 25 per cent of the market – dropped sharply over the last year due to currency strengthening and because of those companies’ weaker performance following the slowing commodity cycle.
The research also showed that pay-outs in the UK banking sector were hit due to the strength of the pound.
Because of that, Capita doesn’t expect Royal Dutch Shell, BP or HSBC – which are three of the five largest dividend payers in the UK – to grow their dividends this year, as they are all currently set for small declines in sterling terms.
If that were to be the case, give the size of those three companies, it would negatively affect the majority of IMA UK Equity Income funds.
However, one of the worst potential victims, at this point in time, would be Clive Beagles and James Lowen’s £2.6bn JOHCM UK Equity Income portfolio, which has been a top quartile performer in the IMA UK Equity Income sector over rolling three, five and seven year periods.
Performance of fund vs sector and index over 7yrs
Source: FE Analytics
FE Trustnet recently highlighted that JOHCM UK Equity Income is one of the highest yielding funds in the sector, but according to FE Analytics, its three largest holdings are Shell, BP and HSBC which combined make up a chunky of 20.54 per cent of its total assets.
Other high profile portfolios such as FE Alpha Manager Francis Brooke’s Trojan Income fund and the £6.5bn Artemis Income fund, which is headed up by Adrian Gosden and Adrian Frost, count those three stocks are prevalent top 10 holdings.
On top of that, Lowen and Beagles also hold mining stocks such as Rio Tinto and Glencore Xstrata as top 10 holdings.
Though some of the FTSE’s largest international earners saw next to no dividend growth, Capita points out that the lower end of the market has, and should continue to, reward equity income investors.
Though the group expects a total income of £99.4bn in to be paid out in 2014, which is £1.7bn lower than their initial forecasts, they anticipate the rate of dividend growth in medium size companies to continue to be faster than their large-cap rivals.
There are a number of UK fund’s which offer a high level of exposure to the FTSE 250, one of which is Thomas Moore’s Standard Life UK Equity Income Unconstrained fund, which was recently recommended by Whitechurch’s Ben Willis.
Moore took over his £463m fund in January 2009 and over that time it has been the fourth best performing fund in the sector with returns of 177.47 per cent having registered top decile returns in 2009, 2010, 2012 and 2013.
Performance of fund vs sector since Jan 2009
Source: FE Analytics
Moore currently holds 45.3 per cent of his portfolio in mid-caps, though he does also hold BP and HSBC as top 10 holdings.
Its clean share class has an ongoing charges figure (OCF) of 1.15 per cent.
