On the one hand there are high dividends available from weakened sectors such as commodities and retail, but investors take the risk of cuts to payouts; on the other there is high growth available from mid-cap companies, but absolute payouts are notably weaker.
To some extent, this trade-off is always a function of dividend investing, but the gap has become markedly wider. In the third quarter, the UK’s mid-sized companies grew their dividends by 30.8% on a headline basis. Admittedly, this included some special dividends, but this was considerably higher than the 4.1% growth exhibited by larger companies. Equally, dividends from larger companies had, in many cases, been given a boost by the weakness of sterling versus the dollar.
However, the absolute level of yield from some larger capitalisation companies is now very attractive. BHP Billiton currently has a yield of 7.28% (source: Morningstar, 19.10.15), Vedanta Resources of 6.99%, Royal Dutch Shell of 6.8% and HSBC of 6.27%. It is clear that many market participants consider some of these dividends under threat. Capita reduced its forecasts for 2016 on the basis that dividend cover was weakening and dividends in the commodities sector looked vulnerable. As it said, “Glencore is one such casualty, but there will likely be others.”
Mark Woods, investment strategy officer at Fairstone Private Wealth, is clear that, to date, the right decision has been to avoid the more distressed parts of the market. He says: “We looked at the performance of the 20 highest yielding FTSE 100 stocks during the peak to trough of the markets this year. They fell over 50% more than the wider market. Normally during a market correction mid and small cap should suffer most, but high yield has bought more capital risk.”
As such, a high dividend has not compensated investors for the higher capital loss, but will this be the same going forward? Hugh Yarrow, joint manager of the Evenlode Income fund, says: “The yield on the mid caps is around 2.5%, compared to 3.6% for the All Share. It is clear that the extra dividend growth available from the mid-caps is being recognised by the market. As a result, we are quite biased to large cap companies at the moment. There are some more attractive yields there.”
Notably, this does not include any of the mining or oil majors, though this is a structural position for the Fund, rather than a reflection of their current prospects. Instead, it includes companies that have been sold off on the basis of their emerging markets exposure. Yarrow says: “These companies have suffered as emerging market currencies have sold off. However, where their underlying businesses remain resilient, they are now quite interesting.” He gives the example of Unilever, where the dividend is attractive, but – importantly – sustainable, unlike some commodities names.
