Following a disappointing start to 2014, UK dividends are expected to grow by more than 5% for the full year against a backdrop of improving outlooks for the UK and global economies, according to Capita Registrars. In fact, Britain is set to grow faster than any G7 nation this year, supported by a falling unemployment rate, a booming housing market, rising investments, and low inflation. The strength of the UK economy, compounded by the latest speeches of Bank of England Governor Mark Carney, has prompted markets to bring forward expected hikes in UK interest rates to early 2015.
The iShares UK Dividend UCITS ETF (IUKD), which offers exposure to the 50 highest yielding UK stocks, is a suitable tool to implement different strategies. This broadly diversified, large and mid cap-focused fund could easily serve as an alternative core UK equity holding for investors seeking a regular income stream. It could also be considered as a satellite holding.
Additionally, this fund may suit investors looking to protect their portfolio from inflation’s effects. Empirical studies have shown that companies that tend to pay out rising dividends generally provide goods and services that are able to keep pace with inflation. For example, utilities, energy and food companies find ways to pass on their input costs to consumers.
Sector-wise, the fund is biased towards financials, which account for 35-40% of the portfolio weighting, while by style, the fund leans towards value. Weighting by dividend yield rather than market capitalisation results in a tilt towards smaller and deeper value companies. Investors looking at this fund should therefore be aware of value traps. A value trap occurs when a company’s dividend yield is high only because its share price is low, reflecting the fact that the company may be in trouble. Also, while some companies may pay large dividends, the effects of capital appreciation/depreciation can dominate the positive income stream.
