With the bonds market not delivering, investors are increasingly trying to harvest income from equities.
However, with UK equity income proving the most popular Investment Association sector through May, Lowry, manager of the Schroder Global Equity Income Fund, warns that these so-called ‘safe havens’ have the capacity to spring a surprise on unwitting investors.
“As with any market, the more saturated equity income becomes, the harder it is to generate a return,” he said, speaking at Portfolio Adviser’s Income event. “It is a very dangerous time to be thinking about and looking for income.
“Most pertinently, companies do not pay out dividends from earnings; they pay them out from cashflow, and there are some sectors in the market where there are huge discrepancies between these companies’ cashflows and the earnings that they purportedly earn.”
Lowry cited the headline yields of oil and gas stocks as prime examples of how some investors are being led down the garden path.
“In the FTSE 250, there are nearly 90 stocks yielding 0-2%, but little more than 30 stocks yielding 5%,” he explained. “While you might expect that in a normal market, the problem with the UK is the skew.
“There are only 30 companies in the 5% bracket, but these companies are huge – £800bn combined market cap – and are paying an awful lot of dividend. Not a single one has 2x dividend cover based on earnings, and the majority of these are oil and gas companies – earnings are a fallacy in of themselves.”
It is an issue which Lowry believes stems from back in 2007, when oil and gas companies were benefitting from climbing commodities prices, with Brent crude hitting an all-time high of $145.61 per barrel in July 2008.
In the years that followed, says Lowry even with the oil price hovering around the $100 mark, while headline dividends looked sustainable on the outside, on closer inspection that proved not to be the case, and with commodity prices now far lower across the board, the problem is being exacerbated.
