Signs of improvement for UK dividends

As the UK starts to emerge from lockdown, pent-up demand from stir-crazy British consumers looks set to kick-start the economy into its fastest period of growth since the Second World War.

But although hugging is back, investors have so far failed to embrace the opportunities in UK equities, instead withdrawing £1 billion from UK large-cap and equity income funds last month alone*.

A year of COVID-19 – the full dividend picture

According to Link’s latest UK Dividend Monitor**, UK dividend pay outs fell 41.6% over the year to the end of March 2021. Two thirds of companies made a cut during the year. Just over half (54%) the top 100 cut dividends, almost two thirds (65%) of mid-250 companies followed suit, but over three quarters (76%) of the UK’s smaller firms were forced to make reductions.

The impact also varied widely from sector to sector. All the banks and nine tenths of companies in sectors dependent on discretionary consumer spending like travel or non-food retail reduced pay outs. But less than half of companies in essential sectors like food production, basic household items and telecoms made cuts.

Food retailers were the real winners, with pay outs up 22%. And it’s worth noting that, amidst all the doom and gloom, more than a quarter of companies managed to increase dividends.

Signs of improvement

Pay outs have continued to fall in the first three months of the year, but there were signs of improvement. “The decline was the slowest in a year, and half of companies increased, restarted or held dividends steady,” the report continued.

The report says that overall, the banks are returning with pay outs between 25% and 40% of their pre-pandemic levels. “Regulatory constraints remain in place for the banks and will mean less in dividends this year than we initially hoped,” it said. “Elsewhere, mining dividends are going to be stronger than we had pencilled in as profits are boosted by commodity prices driven higher by the global economic recovery. We also see a better-than-expected 2021 for media, insurance, telecoms, building materials and utilities, whereas oil dividends and pay outs from housebuilders look set to be a bit lower than we had imagined three months ago.”

Finding yields of 3% or more

In terms of expected income, Link expects the market to yield around 3%, with the top 100 companies set to yield more than twice the mid-caps at 3.4% and 1.6% on a respective best-case basis. “2025 is still a realistic target for regaining 2020 highs,” the report concluded.

Richard Colwell, manager of Threadneedle UK Equity Income, talked to us about UK dividend recovery earlier this year in this video interview: [3:40]

Five Elite Rated UK Equity Income funds yielding 3% or more

When it comes to equity income funds, some funds look for a growing dividend from their underlying holdings, while others like to target yields of a certain value. Some combine these factors.

Sue Noffke, manager of Schroder Income Growth, for example, constructs the portfolio to ensure that the fund is capable of delivering its dual income objectives – an attractive dividend to investors today, as well as securing growth of the dividend after adjusting for inflation. “We select a mix of stocks combining different income characteristics to achieve this,” this said.

The yield on funds and trusts can also vary. Almost all the UK equity income funds on FundCalibre currently yield 3% or more***.

Those looking to beat the market yield may like to consider these five funds and trusts:

City Of London – 4.94%^ yield

Investing predominantly in larger UK companies with international exposure, this trust has been managed by Job Curtis for 30 years. With tactical use of its revenue reserves it has increased its dividend payment every year for the past 54 years.

Man GLG Income – 4.25%^ yield

This fund has a value-driven approach. It invests no less than 80% in UK companies of all sizes but can also invest in European firms that derive a substantial part of their revenues from the UK, and selectively in corporate bonds.

Murray Income Trust – 3.8%^ yield

The manager of this trust targets resilient companies which can thrive in any economic scenario and can also use call options. “We continued to write options [in April] to gently increase the income available to the fund including calls on Croda, Prudential, Smith & Nephew and VAT Group.”

GAM UK Equity Income – 3.71%^ yield

This fund invests in companies of all sizes – from the very small and those listed on the AIM stock market, through to the FTSE 100. The manager believes dividends are the most important driver of total returns and while he is targeting a yield higher than that given by the UK stock market, he is also looking for steady dividend growth.

Montanaro UK Income – 3%^^ yield

This fund focuses on small and medium-sized businesses. Each holding will also offer an attractive dividend yield or the potential for dividend growth. In a recent video interview, the manager said: “More than 40% of the companies in our fund have cash on their balance sheets – they could have paid dividends last year but instead were cautious. This gives us confidence that dividends will come back sharply this year – in fact, some have already reinstated them, and others have paid special dividends to make up for the cuts last year.”

* Source: Morningstar, FT Adviser, 19 May 2021
**Source: UK Dividend Monitor Issue 45 | Q1 2021
***as at 24 May 2021
^Source: fund fact sheet, 30 April 2021
^^Source: fund factsheet, 31 March 2021