UK equity-income funds struggle for yield

As dividends shrivel in the wake of the credit crisis, UK equity income managers face the challenge of finding alternative income sources

Chetan Modi 19 November, 2009 | 2:39PM

The immense scale of the credit crisis and the recession that has followed has forced companies to reassess their ability to pay dividends. The near-demise of major banks has wiped out a crucial dividend-paying sector for UK equity income managers—they now face the challenge of finding alternative sources of income for their investors.

Life after the banks
In February 2006, the average fund in the IMA UK Equity Income sector held over 30% in financial services; fast-forward two years and by 31 March 2009 that average exposure had halved to less than 15%. Although it’s risen throughout 2009 to an average of 20% by the end of September—following a sharp rally in the sector since March—it is no longer the rich and reliable source of income that it once was. Royal Bank of Scotland, Halifax Bank of Scotland and Lloyds are not paying a dividend in 2009 and are unlikely to reverse this in the near-term, given their part-ownership by the UK Government. Although independent of government shackles, Barclays and HSBC have also cut their dividends.

This trend is not just limited to the banks; companies such as BT and Xstrata have also cut dividends. Indeed, the number of reliable sources of income has fallen considerably, resulting in a handful of names such as BP and Royal Dutch Shell appearing in the majority of equity income portfolios for the relative safety of their dividends. Both companies declare dividends in US dollars but pay in sterling or euros so, for the 2008 final quarter and 2009 first quarter payments, fund managers received a boost from the dollar strengthening against sterling. But this trend has been reversing since March this year and the fall in price of crude oil could put pressure on their capital expenditure requirements, forcing them also to cut. Indeed, Neil Woodford of Invesco Perpetual has sold his entire stake in both companies on such fears. And let’s not forget the introduction of currency risk too where companies are not paying in sterling. This is yet another reason why managers need to diversify their sources of income.

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About Author

Chetan Modi  is a fund analyst at Morningstar OBSR.

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