The UK remains one of the strongest equity income paying markets in the world. It hosts a suite of multi-national corporations with long records of paying steady and rising dividends. More and more these strategies are being rewarded by investors, in part because of the thirst for yield amid record low bond yields and interest rates, but also because of its tendency to signal quality to investors: strong cash-flow, robust balance sheets and good corporate governance. If management is not spending money on important projects they are returning cash to shareholders, signalling to the market their continuing confidence in the business’ success that will in-turn bring fresh revenues for further projects. It can be true that companies awash with cash will eventually start to waste it.
But there’s a slight structural issue in the UK stock market: the top 20 companies pay 70% of all UK dividends; the top 10 pay 50%; the top five pay 35%.
Research by Janus Henderson has taken a closer look – analysing all of the UK equity income funds and investment trusts above £200m to see who holds what and in what concentration.
It was found that 26% of the money managed by the entire sector is invested in the following top ten stocks:
GlaxoSmithKline
AstraZeneca
Imperial Brands
Royal Dutch Shell
BP
British American Tobacco
HSBC
Legal & General
Vodafone
Aviva
Out of the 52 funds and investment trusts we looked at, the top ten stocks were held by this many of the portfolios:
Source: Janus Henderson Global Investors, Morningstar; as at Oct 2016.
It demonstrated that all of the top ten stocks are held, on average, by 70% of the funds in the sector. This is actually unsurprising: As equity income portfolios get larger, fund managers are forced to hold these same largest companies in order to receive enough dividends to pay all of their shareholders. It is further evidenced by the fact that, of the largest equity portfolios in the UK, the average percentage of the total portfolio held in these top ten stocks was 39%. When the liquidity pool is small, fund managers simply have little choice.
The percentages shift around over time but it does raise the idea of concentration risk. UK based investors are likely have the majority of their interests focused here, be it their job, houses, cars, investments, and so forth. Investors also often hold multiple funds to try to protect against a singular manager’s poor performance, but they are likely duplicating across many of the same stocks.
What happens when something goes unexpectedly and spectacularly wrong – oft referred to as a black swan event? The Macondo oil spill in 2010 is a good example, when BP was forced to cut its dividend amid the rising and uncertain cost of the disaster. As one of the top five dividend payers in the UK this led to substantial shortfalls for equity income fund managers.
Janus Henderson International Income Trust (HINT), managed by Ben Lofthouse, was launched exactly for these reasons in 2011. It is mandated to invest globally in income yielding equities but importantly it excludes the UK entirely, offering investors the chance to diversify away from their UK based investments and sources of income. What is more, the types of businesses that deliver strong levels of dividends tend to differ between markets, meaning sector-level diversification is also possible in addition to the geographic diversification.
HINT is also an investment trust and we strongly believe this structure benefits investors seeking income – in any given year the fund manager is able to retain up to 15% of dividends in a reserve pot, so that during difficult times when stock markets are down and perhaps dividends are being cut, the fund manager can use the reserve to top up the income paid out to investors. The effect is to smooth the dividend stream paid-out over time, which may be useful to those who heavily rely on the income.
Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser.
The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.
Issued in the UK by Janus Henderson Investment Funds Limited (reg. no. 2678531), incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE, is authorised and regulated by the Financial Conduct Authority to provide investment products and services.
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