The UK market may have lost the attention of investors in recent years, but the latest Computershare Dividend Monitor showed it can still hold its own as a dividend powerhouse. In spite of this, outflows continue from the once-popular UK equity income sector. Are investors missing a trick?
The UK remains one of the highest dividend-paying markets in the world. The FTSE All Share has a dividend yield of 3.9%, with the FTSE 100 on 4.5%. Even the FTSE Small Cap has a yield of 4.1%. No other major market comes close – the FTSE World yield sits at 2%, while North America is just 1.5%. Of the developed markets, large-cap European equities are the sole challenger (3.2%) and only Latin America (6.7%) is ahead.
Not only is the absolute level of dividends high, but the UK continues to see strong dividend growth. The latest Dividend Monitor showed that regular dividends (excluding one-off special dividends) rose to £88.5bn in 2023, up 5.4% on a constant currency basis. This growth rate accelerated to 15.6% in the fourth quarter as HSBC restored its quarterly payouts in full for the first time since the pandemic. Increased banking dividends meant the sector was the biggest dividend-payer for the first time since before the Global Financial Crisis.
There had been concerns about the mining sector as it leaned into its cyclicality. Many companies moved to variable dividend payouts, which was the key contributor to the fall in special dividends, with total payouts falling more than a quarter year-on-year. However, it did not dent dividends overall, with a 15.8% increase in dividends from the oil sector and a boost for the utilities sector, which has inflation-linked dividends. Leisure companies, which are recovering after the pandemic, also delivered a significant dividend increase.
UK buybacks
Dividend growth would have been even more impressive – 7.2% versus 5.4% – had companies not embarked on significant share buyback programmes. At the same time, no-one is expecting this party to end. The report forecasts dividend growth of 2% for 2024, with higher special dividend likely to drive the headline total up an additional 3.7%. Dividend cover is well above 2x.
Yet this all falls on deaf ears for investors. Money continues to flow out of the UK equity income sector. Since the Brexit vote in 2016, funds in the UK equity income sector have dropped from £58.9bn to £34.7bn, a slide of 58% and five places in the overall sector rankings. The global equity income sector has been the key beneficiary, rising from £14.4bn to £22.8bn (41%) over the same period.
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This weakness shows no sign of abating. It saw the seventh largest outflows in November, at £201.2m. This compares to £242.5m in October, and £333.4m in September. At the same time last year, outflows were running at a similar level – around £200m in November 2023, according to the Investment Association.
There are glimmers of hope from the investment trust sector. The Association of Investment Companies found that more than half of its top 20 ‘most searched for’ funds were dividend heroes – those investment trusts that have increased their dividends for at least 20 years in a row. It was a UK fund – the City of London Investment Trust, with its 57-year track record of dividend increases – that took the crown, as Merchants and Murray Income followed as other popular options.
Value in value
Rob Burdett, head of multi-manager at Columbia Threadneedle, says there is real value showing up in this part of the market: “In a choice between the UK and global equity income funds, we believe the UK has been under the cosh too long and there could be some uplift in capital values.”
He suggests dividends should receive a modest boost from higher earnings and inflation. The managers his team are talking to are also expecting steady growth over the year.
James Lowen, senior fund manager on the J O Hambro UK Equity Income fund believes that even if buybacks depress dividend growth in the short-term, they may be a driver for UK share prices and dividends in the longer-term: “In respect of boardroom frustrations around low UK equity valuations, a notable trend is emerging, with companies resorting to share buybacks to address the challenge. This is particularly evident in sectors such as banking, where buybacks are being extensively used.
“Over the long term, the anticipated effect is to amplify dividend growth, as there will be less shares in issue for the dividend to be spread across. This is a powerful second derivative effect of buybacks for long term dividend growth, which we see in numerous stocks.”
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Their team’s dividend forecast incorporates a shift towards lower dividends and increased buybacks from 2024 which could result in a short-term dip, but they are projecting higher returns in the medium term. Lowan adds that there are clear areas of dividend strength such as the oil, banking, and insurance sectors, and that aggregate dividend cover is very strong.
In terms of capital values, several of the elements that have dented sentiment towards UK markets are becoming more neutral. For example, the UK may benefit from the anticipation of greater political stability in the second half of the year and any pre-election giveaways from the incumbent government as it strives to shore up its popularity.
Equally, the UK economy may continue to flirt with recession, and there is nothing to suggest an imminent improvement, but neither is it significantly behind its peers. Jonathan Winton, co-manager of the Fidelity Special Values trust, says: “UK equities are significantly undervalued and are compensating for some economic risks to a degree. The UK generally looks very attractive compared to other parts of the market.”
He points out that UK equities should benefit from any rotation into value stocks, and that recent performance hasn’t been nearly as bad as some suggest – the MSCI UK is ahead of the MSCI World ex UK index since 2020.
There remain limitations to the UK equity income. It is still concentrated in a small number of ‘old economy’ sectors, such as banking, energy and mining. One-third of dividends still come from just five companies – HSBC, Shell, Glencore, BAT and Rio Tinto.
However, the relatively high yield on smaller companies suggests there are a range of options for active managers. Equally, while it is undoubtedly an imperfect sector, its positive elements have been significantly overlooked by investors in recent years.
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