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January 2016 - The importance of income

January hasn't started very auspiciously for equity markets. Trading has been suspended on the China stock exchange twice now after falling 7% on two occasions, with most other markets falling too as a consequence. This comes after a disappointing 2015 when, having reached an all-time high in April, the FTSE 100 finished almost flat. At the time of writing it has dropped below the 6,000 mark*.

At times like this it's worth remembering that total returns are made up of both capital appreciation and income payments, and reminding ourselves just what a difference the income element can make to our portfolios. For example, in 2015, the price return of the FTSE 100 was -4.93%** but the total return, which includes reinvested dividends, was -1.92%.** This was even more pronounced in emerging markets where the price return was -12.15%** compared with a total return of -5.76%**. Of course, this income doesn't have to be reinvested, and a lot of our clients like to take it as a payment instead.

Sustainability of income

When looking at investment income, it is important to consider both the level of the yield and its sustainability.

Dividend growth has been good in the UK in the past few years but, despite a reasonably strong economy, there are now some questions about whether the largest companies in the market can maintain or grow their payouts. For example, Shell hasn't raised its dividend for nearly 2 years and Glencore cancelled its dividend altogether. They just don't have the spare cash any more. Another reason is that the big supermarkets, like Sainsbury's and Tesco, have been hit hard by a fierce pricing war and they too, are looking to preserve their cash reserves. The outlook for smaller and medium-sized company dividends is better.

Elite Rated equity income funds, which can invest in any size of company and which have a good track record of growing their dividends, include Standard Life UK Equity Income Unconstrained, which has increased its dividend each year since 2009, Threadneedle UK Equity Income, which has increased its dividend each year since 2010 and Rathbone Income, which has increased its dividend in 22 of the past 23 years. Quite an astonishing record.

Going global

The UK isn't the only place to find income paying stocks, however. On aggregate, global dividends have risen more than 56%*** since 2009. Henderson expects them to have increased by around a further 4.1%*** next year. So for fund managers looking around the globe, there are still plenty of good opportunities. If you wanted to be more specific about your investment choice, you could look at a regional fund instead.

US dividends have increased by 10% year on year,*** with strong growth across almost all sectors of the economy. Over the past six years, dividend payments have almost doubled. Japan is another area that is becoming increasingly interesting. Japanese companies have one of the fastest annual dividend growth rates in the world at 22%.*** Elsewhere in Asia the story is similar, with Taiwan and South Korea leading the way, albeit with the latter starting from a low base.

Elite Rated funds of this ilk include BlackRock Continental European Income, Schroder Asian Income and Charlemagne Magna Emerging Markets Dividend.

Equities not the only asset

Of course, equities aren't the only asset which produce an income. As regular readers will know, bonds are not our favoured investment at the moment as interest rates have started to rise in the US, but they do still have a valuable role when it comes to income. As Mark Holman, CEO of the bond specialist company TwentyFour Asset Management said recently, a decent level of yield will help shield bond funds from some of the capital losses that could result in a rate rise cycle.

Of the five Elite Rated funds producing a yield of around 5% or more, four are bond funds: Invesco Perpetual Monthly Income Plus, Invesco Perpetual High Yield, Baillie Gifford High Yield and Aberdeen Emerging Markets Bond. As with all investments, there are no guarantees and a higher level of yield usually means a higher level of risk, but the first fund from Invesco in particular has a good record of maintaining its yield too.

Let's also not forget property. The yield on physical property has fallen over the past year or so as demand for the asset class has increased, but it is still attractive and on a par, if not ahead, of many bonds. Elite Rated Henderson UK Property Trust, for example, has a current yield of 3.1%****.

* 7th January 2016
** Source: FE Analytics, 1st December 2015 to 31st December 2015. Price and total returns in GBP
*** Source: Henderson Global Investors, 30th September 2015
**** Source: FE Analytics as at 31st December 2015

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Sam Slator, Head of Communications - January 2016

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