Tineke Frikkee, manager of the Newton Higher Income Fund, has warned investors that some of the UK’s equity income funds may see a significant fall in yield before the end of the year.&
Tineke Frikkee, manager of the Newton Higher Income Fund, has warned investors that some of the UK’s equity income funds may see a significant fall in yield before the end of the year.
‘Whenever an interim dividend is passed without an indication as to whether or not the final dividend will be paid, the FTSE always assumes that the previous year’s final dividend will be paid. Because of this, at times of severe pressure on dividends, the published dividend yield tends to overestimate the eventual annual dividend. This is then followed by ‘step-change’ falls in published dividend yields as official notifications catch up with wider expectations of cuts,’ says Frikee.
The most extreme example of this was in November last year when severe market weakness drove the yield on the FTSE All Share to a 28-year high of 6.11 per cent. A week later, when the dividend cuts made by the UK banks were factored in, the yield on the FTSE All Share dropped to 4.7 per cent. Since then, further dividend cuts and rights issues, coupled with strong price performance, have pushed the market’s yield down to 3.5 per cent.
Frikkee says this sort of lag can jeopardise the yields published by UK equity income funds.
‘We’re able to avoid such pitfalls because we only use our own proprietary dividend forecasts. This is central to our approach as we only ever invest in stocks which yield more than the wider market. It’s also why we’ve been able to steer around the worst dividend cuts of the last year. By avoiding areas such as UK banks, pubs, property and house building stocks we have continued to grow the dividend on the Newton Higher Income Fund even while many of our peers have been forced to announce cuts.’
Yields in the IMA UK Equity Income sector have already fallen in recent weeks following many funds going ex dividend at the end of June and Frikkee has been quick to warn that more of the same is likely before the year is out.
‘We expect to see this again in December, as those managers who don’t adjust their portfolios could face a serious hit to the dividends they collect. In September alone the interim dividends from Rio Tinto and Legal & General will be down by 100 per cent and 55 per cent respectively, while October will see a 100 per cent cut in Rexam’s interim dividend. By contrast, because we’ve always set out to grow annual income, we expect to deliver around three per cent dividend growth to the end of June 2010, even though the Newton Higher Income Fund already offers a seven per cent yield – one of the highest in the industry.’
Areas of most interest to dividend investors will naturally include the banking and mining sectors, says Frikkee, but there is no shortage of clues as to where the best value currently lies.
‘Right now there are some very attractively valued blue chip stocks offering high and sustainable dividends. Dividends from the UK oil majors look particularly robust,’ she says. ‘Oil stocks currently pay almost double the market yield suggesting to us that they remain seriously undervalued. Elsewhere, high yielding stocks such as GlaxoSmithKline and British American Tobacco are actually growing their dividends. Such trends have helped the FTSE 100 Index to generate a 33 per cent yield premium to the FTSE 250 Index which, with a yield of 2.75 per cent is much in line with its level at the end of 2003, when shares were recovering strongly. We think that’s rather optimistic and consequently we continue to favour FTSE 100 stocks mixed with selective high yielding, medium-sized companies.’
