The UK income market took a major hit in 2020 when dividends were slashed at record levels, but there are signs of optimism for income investors this year.
In 2020 UK dividends were cut with “unprecedented speed and ferocity”, in Q2 according to the Link UK Dividend Monitor. During that time 176 UK companies cancelled its dividend and 30 more announced cuts, making up three-quarters of usually dividend paying UK companies.
This was worse than dividend cuts or cancellations in the aftermath of the 2008 global financial crisis, as companies struggled to shore-up balance sheets while dealing with the financial impacts of Covid-19.
And while the UK has entered a third lockdown there is some cause for optimism, with an aggressive vaccine roll out and better understanding of the virus. Also, a Brexit deal was finally agreed at Christmas, removing some of the uncertainty which had clouded the UK market outlook since the 2016 referendum.
For income investors specifically there was good news towards the end of last year, indicating that 2021 might be a more positive period for dividends especially.
Indeed, in December UK banks were told by the Prudential Regulation Authority (PRA) that they could start paying shareholder dividends again, after being told previously to cancel payouts last March.
The restart of such a major dividend source was an encouraging sign that UK income could have a more positive year in 2021.
Darius McDermott, managing director of Chelsea Financial Services, said that while UK equity income funds have had a “torrid time” recently, he does see opportunity going forward in more value areas of the market.
He said: “Not only could the share prices of these companies be given a boost by more certainty and positive news flows but given the cuts in dividends we’ve experienced in 2020, there is a lot of scope for dividend growth too.
“While many bourses around the world have regained their pre-Covid highs, ours has not and it remains cheap compared with its global peers.
“So, valuation support, some post-deal Brexit positivity, attention from investors and another vaccine bounce may all lead to better times ahead.”
Below, McDermott highlights four income funds that could benefit if dividends make a comeback in 2021.
Artemis Income
McDermott’s first fund pick is the £4.4bn Artemis Income fund, which he said has been “a stalwart of the UK equity income sector for two decades and has an excellent team and a strong process”.
Run by Adrian Frost since 2002 with co-managers Nick Shenton and Andy Marsh joining in 2012 and 2018 respectively, the managers focus on companies’ free cash flow yield – taking into account current and prospective dividends and the likelihood of dividends being maintained.
“It is designed to offer a diversified, eclectic mix of cash flows from different companies to ensure a sustainable and durable income,” McDermott said.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over the past three years, Artemis Income has made a total return of 4.97 per cent, outperforming both the FTSE All Share benchmark which made a loss of 1.56 per cent and the IA UK Equity Income sector which also made a loss and is down by 3.25 per cent.
The fund has a yield of 3.54 per cent and has an ongoing charges figure (OCF) of 0.81 per cent.
GAM UK Equity Income
The Chelsea Financial Services managing director’s second option is the £182.1m GAM UK Equity Income fund overseen by Adrian Gosden and Chris Morrison.
Investing in companies of all sizes, at least two-thirds of the fund must be invested in UK equities, with the managers able to invest the remainder in non-UK options, fixed interest, bonds or cash.
The managers’ process is based on fundamental valuations, looking for the ‘most attractive’ options. Companies which they think are both interesting and profitable opportunities.
In its top-10 the fund holds some well-known income names, such as Royal Dutch Shell, Imperial Brands, BP and British American Tobacco.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over the past three years, GAM UK Equity Income has made a loss of 7.98 per cent, underperforming both the FTSE All Share index and the IA UK All Companies sector.
The fund has a yield of 3.95 per cent and an OCF of 0.67 per cent.
LF Gresham House UK Multi Cap Income
The third pick is LF Gresham House UK Multi Cap Income, the only fund highlighted by McDermott which is under £100m in assets under management.
With an FE fundinfo Crown rating of five, the £77m fund has been managed by Ken Wotton and deputy manager Brendan Gulston since launch in 2017.
According to McDermott the managers have “unrivalled experience in the small-cap space”.
A concentrated, multi-cap portfolio which focuses on predominantly UK-listed small- and mid-cap companies, McDermott said this fund is “a compelling choice for those looking for capital appreciation and an attractively growing income”.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
Over three years, LF Gresham House UK Multi Cap Income was the top performer in the IA UK Equity Income sector, with a total return of 20.42 per cent. It has a yield of 3.45 per cent and an OCF of 0.86 per cent.
Schroder Income
The final fund pick is the £1.5bn Schroder Income fund, overseen by Kevin Murphy and Nick Kirrage.
“A deep value-driven fund that invests in companies valued at less than their ‘true’ worth and waits for a correction,” McDermott said. “It tends to avoid the big income producers in favour of more niche names, where both capital as well as income can grow significantly.”
Focusing on companies with ‘value’ characteristics, such as cash flows, dividends and earnings to identify securities these are assets which Murphy and Kirrage think are undervalued by the market.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
However, Schroder Income fund has underperformed both the sector and index over the past three years, with a loss of 9.49 per cent, as its deep value style has been out of favour. The fund has a yield of 4.96 per cent and an OCF of 0.91 per cent.