Has the tide turned for UK equity income in 2024?

In the dim and distant 2000s, UK equity income was the hot sector. Home to a raft of star managers, it was the bedrock of many investors’ portfolios. Investors liked it for its reliability and stability. However, the past decade has seen it fall substantially out of favour, as investors have found greater enthusiasm for global sectors and become disillusioned with the UK.

Setting the scene

Prior to the Brexit vote in May 2016, the UK equity income sector was £58.9bn, the fifth most popular sector, forming around 6.5% of overall open-ended funds under management*. The global equity income sector was a relative minnow, at just £14.4bn, having launched in 2011*. 

By November 2023, the UK equity income sector had shrunk to just £34.7bn in size, dropping to 10^th in the ranking and just 2.9% of overall funds**. This is a drop of 58%. In contrast, over the same period, the global equity income sector grew to £22.8bn, a rise of 41%**. 

The reasons for this weakness are well-documented: poor sentiment post-Brexit; the weakness of key sectors such as banking and commodities, and the ‘old school’ flavour of many UK equity income funds (the likes of banks and energy companies) at a time when investors wanted technology and growth. 

Are the tides turning?

The environment has changed significantly over the past 18 months. The relative performance of UK equity income funds has improved. At the same time, the sector is home to a raft of highly talented stockpicking managers – from Adrian Frost (Artemis Income), to Carl Stick (Rathbone Income), to Nick Kirrage and Kevin Murphy (Schroder Income). All have a sound track record of finding opportunities even in the dullest markets. Could it rediscover some of its lost popularity?

A reliable source of dividends

The UK market still scores highly for its dividend characteristics and for many income investors, this will be a greater priority than capital growth. The desire for a high and growing dividend is seen in the popularity of many equity income investment trusts. 

In January, the Association of Investment Companies published its list of the 20 most viewed investment trusts on its website during 2023. More than half were ‘dividend heroes’, investment trusts that have increased their dividends for at least 20 years in a row. The City of London Investment Trust, with a 57 year track record, is top***. 

The UK market remains one of the most reliable sources of dividends in the world. The absolute level of dividends is high. The FTSE All Share has a yield of almost 4%****. This is higher than any other market except for Latin America****. The FTSE World has a yield of just 2%, North America is just 1.5%****. Only large-cap European equities come close, with a yield of 3.2%****. 

Underlying growth in UK equities is still robust, at 2.4% – and excluding the mining sector, it was an impressive 7.2%^ in the third quarter of 2023. In the wake of the pandemic, dividend cover (the extent to which a company’s dividends are covered by its earnings) has jumped higher, meaning that dividend payouts look reliable, even if capital values continue to bounce around. 

Why does UK equity income remain unloved?

However, no-one wants to be actively losing money on their equity income fund, even if their income is growing. The UK still has plenty of risk factors. 

Carl Stick, manager of Rathbone Income, is aware of the limitations of the UK market: “The FTSE 100 celebrated its 40th birthday by hitting an all-time high at the end of the year, but this does not change the fact that the UK market has been in the relative doldrums for half its life, substantially lagging the S&P 500. We can evangelise all we like about the cheapness of the UK market, but the brutal reality is that it remains unloved and lacking vitality.” 

However, while he admits the UK has been dull, he points out that UK equity income funds have delivered a creditable performance over the past three years. It is the sixth best performing sector, with the average fund rising 18%^^. 

He adds: “Policy is starting to move in the right direction: full expensing of capital investment, made permanent in the Autumn Statement, makes the UK’s regime the most attractive in the OECD. We hope there is a renewed will to change, and the UK market is cheap enough to reward us for our patience. Investment means playing the long game.” 

Best-performing Elite Rated UK equity income funds

Improving sentiment for UK equity income

Some of the factors that have dented sentiment towards the UK are starting to reverse: 

• • The UK’s political situation appears less precarious than a number of its neighbours.
  • The UK economy is undoubtedly still weak, but it is not discernibly weaker than many of its European peers. 
  • The Bank of England remains reluctant to raise interest rates. This favours the types of companies that populate many UK equity income funds – defensive companies with high predictable dividends and cash flows. 
  • The final element is – counterintuitively – its unpopularity. 

Major institutional investors have long moved away from the UK market, with UK pension fund holdings in the UK market stable at just under 2% after a long period of decline*^. Valuations look low compared with other developed markets on almost all measures – dividend yield, price to earnings ratio, price to book. These valuations provide a significant cushion for investors.  

Andrew Jones, manager of the Janus Henderson UK Responsible Income fund, says: “There continues to be a large valuation discount applied to the UK equity market, both relative to other markets and its own history. This is particularly true for domestically-exposed companies, where, in general, valuations have already reverted to recessionary levels.” Nevertheless, he is still finding plenty of companies with robust free cashflow characteristics and strong balance sheets that should be well-positioned to navigate the still uncertain economic environment.

The UK equity income sector will never be rock ‘n’ roll, but it does have real appeal for those looking for a reliable and growing income stream. Equally, the prevailing environment is likely to be more favourable to equity income strategies and the UK more broadly from here. There are still risks, but the UK market’s low valuations provide a significant cushion.   

*Source: Investment Association, May 2016

**Source: Investment Association, November 2023

***Source: AIC, 11 January 2024

****Source: Morningstar, data at 19 January 2024

^Source: Computershare, UK Dividend Monitor, Q3 2023

^^Source: FE fundinfo, cumulative performance in pounds sterling, at 23 January 2024 

^^^Source: FE Analytics, total returns in sterling, 22 January 2021 to 22 January 2024

*^Source: Office for National Statistics