Shore up your income by looking overseas

Total UK dividends fell 5 per cent over the first quarter of 2016 to $16.4bn (£11.57bn) largely impacted by sterling's fall against the US dollar, but underlying growth was still only 0.7 per cent, according to the Henderson Global Investors Dividend Index report. It adds that since 2009 UK dividend growth of 44 per cent has lagged well behind the global average of 59 per cent, making it the second slowest growing region over this period.

And the Capita UK Dividend Monitor says that during the first quarter of 2016 five companies alone accounted for 53 per cent of the total payout. If any of these companies cancelled their dividend payments this would have a highly detrimental effect on the overall total. Investors had some experience of this during the financial crisis when some banks, an important contributor to UK equity income, cancelled their dividends.

Even if you hold a few UK equity income funds you are probably not diversifying your income as much as you think, as it is likely there is significant overlap in terms of the shares they hold, due to the decreasing number of options available in the UK market.

"UK income investors are heavily dependent on oil, banks and mining companies, which together make up almost half of the country's equity income," says Alex Crooke, head of global equity income at Henderson Global Investors. "Now the sharp downturn in the mining sector is hitting shareholder income hard. It's times like these that demonstrate the risks to investors of such a heavy reliance on just one or two sectors. Thinking globally really helps diversify this risk away, not only from a sector perspective, but from a geographic one too."

"Dividend cover in the UK is not healthy, with several large dividend payers maintaining their dividend by drawing on retained income from previous years' profits," adds Adrian Lowcock, head of investing at AXA Wealth. "This is only sustainable in the short term. Income seekers need a combination of healthy dividends and dividend growth. Geographical diversification also helps protect investors from the effects changes in currency can have on dividends."

If the UK votes to leave the European Union later this month and as expected sterling weakens, it could be beneficial to have some exposure to overseas currencies.

Look further afield

Because of the problems in the UK it could be a good idea to consider some overseas equity income funds. The headline yield figures for some foreign indices don't necessarily look that good against the UK: the S&P 500, for example, only yields about 2.17 per cent and MSCI World yields 2.63 per cent, compared with 3.75 per cent for the FTSE All-Share. But those are overall averages, and within those indices there are companies paying good and reliable dividends.

A dividend-paying culture is also being increasingly adopted in a number of overseas markets where they didn't once have one, for example, Japan.

Over the first quarter globally dividends grew 2.2 per cent to $218.4bn, according to Henderson Global Investors Dividend Index. 60 per cent of these were paid in North America where they rose 6.3 per cent on a headline basis, with growth in every sector except mining and oil. Henderson is forecasting global dividends of $1.18 trillion in 2016, up 3.9 per cent on a headline basis.

In Europe ex UK dividends grew 10.8 per cent to $38bn over the first quarter, with Swiss pharmaceutical stocks accounting for one-third. "The outlook for European dividends over the important second quarter reporting season is promising," says Henderson.

By diversifying you are more likely to be able to maintain a reliable income stream as you are accessing a much bigger universe, and you diversify your overall equity exposure, which should help to reduce concentration risk. You get access to different companies, and some sectors that are not well represented on the UK market, for example technology and automotive. Technology was the fastest growing sector for dividends in the first quarter, according to Henderson, which predicts these types of company will pay almost 8 per cent of global dividends this year.

Picking a fund

When choosing an overseas equity income fund don't just go for the one with the highest yield - pick one with good long-term total returns, as there's no point having a high income if you're losing capital.

But look at how the fund's yield compares to its benchmark index - it should be doing better than this. And check the fund's record of dividend payments and how much these have grown over the years: it is important that the fund keeps growing its divided payments to keep pace with inflation.

Also check the charges: an open-ended fund purchased from an investment platform will typically have an ongoing charge of between 0.75 per cent and 0.9 per cent.

Overseas equity income funds fall into different categories: global funds, and regional funds focused on Europe, Asia, the US or emerging markets.

A global equity income fund is a good option for most investors as they should provide diversified exposure, and are potentially lower risk than a regional fund because they do not rely on the fortunes of only one region. If a given region or sector is having problems, global equity income fund managers have multiple options for allocating elsewhere. But this also means that when a particular region or sector is doing well, a global fund may not do as well as a fund only focused on that area.

Make sure the global fund you choose is well diversified globally and not significantly allocated to the UK. If it has a high percentage of assets here then you may be duplicating what you already have in your UK equity income funds and any direct share holdings, and it won't diversify your portfolio as much.

Global fund suggestions

Artemis Global Income (GB00B5N99561) has made good returns since it launched in 2010 and is among the top five performing funds in the Investment Association (IA) Global Equity Income sector in terms of total return over three and five years. This IC Top 100 Fund also beats MSCI All Country World Index over those periods.

This means that, over the long term, the fund is growing your money as well as paying you dividends, and it has an attractive yield of 4.26 per cent.

It is well diversified with 43.6 per cent of its assets in continental Europe, 32.4 per cent in North America and only 7.3 per cent in the UK.

"This adopts a value bias looking for cheaper, out of favour equities," says Mr Willis.

This can be a good approach as equity income shares can be relatively expensive due to their popularity with investors seeking an attractive yield amid low interest rates and poor returns on bonds.

Newton Global Income (GB00B8BQG486), another IC Top 100 Fund, has been running for over a decade so has a track record of investing through different economic and market conditions. "This is a core, relatively defensive fund that aims for higher quality companies with sustainable dividends," says Mr Willis. "It is a good long-term hold and ideal for lower risk portfolios."

The fund's holdings must yield at least 25 per cent more than the FTSE World Index. It has a bias towards large-cap stocks from developed markets with above-average dividend yields, meaning it has a slightly lower-risk profile than the UK stock market. But these characteristics mean it is also likely to lag cyclical or momentum-led market rallies.

It is among the top two performing funds in the Global Equity Income sector in terms of total return over one, three and five years, and also beats MSCI AC World Index over these periods. It yields 3.9 per cent.

More than half of its assets are in North America with about 23 per cent in continental Europe.

Because it takes a slightly different approach to Artemis Global Income Mr Willis says that "These two funds complement each other and work very well when held together within a portfolio."

Fidelity Global Dividend (GB00B7778087) only launched four years ago, but has been making strong returns and yields 3.3 per cent. It is the top performing Global Equity Income fund over three years, and among the top five over one year.

This fund aims to grow its income ahead of inflation and 25 per cent more than the MSCI All Country World Index.

"Its manager Daniel Roberts runs an unconstrained fund and does not follow indices or benchmarks," says Mr Lowcock. "Each stock is selected only for its income potential. However he also operates a total return focus in that he looks to invest in companies that pay a sustainable and growing dividend, and does not chase an income at the expense of capital growth.

"His approach could be described as long-term value - he looks for companies which look attractively valued over the whole cycle or longer term, not just based on current valuations. This fund is run with a cautious view and capital preservation is an important component."

Fidelity Global Dividend has about 35 per cent of its assets in the US and 31 per cent in Europe ex UK.

Suggested funds

Source: Morningstar

Performance as at 10 June 2016

*Indicates the performance of an older share class than the one mentioned in the text

Regional equity income funds

Regional funds are in theory higher-risk because what they generate rests on the fortunes of one region. However, if you have a large portfolio you could hold some regional equity income funds alongside your UK and global equity income funds, which could provide stronger returns.

A number of European companies are offering attractive yields, and MSCI Europe ex UK Index has a dividend yield of 3.66 per cent.

While facing both external and internal economic challenges Europe could surprise on the upside in 2016. In any case, many of the companies listed on the stock exchanges in this region are some of the world's largest and strongest, and make their revenues from around the world. Their payout ratios are generally not extreme, which means there is scope for dividend growth.

But there are still problems in Europe and the potential for policy mistakes, which means stock markets and share prices could fall due to investor sentiment - even if the companies your fund invests in are trading well and are profitable.

Darius McDermott, managing director at Chelsea Financial Services, suggests BlackRock Continental European Income (GB00B3Y7MQ71). This is among the top 10 performing funds in the Investment Association Europe ex UK sector over one, three and five years, and yields 4.66 per cent.

This fund's managers look for undervalued high-yield or quality stocks that offer reliable, sustainable dividends, potential dividend growth and protection against inflation, with lower than average risk.

Asia Pacific ex Japan also has a number of companies offering attractive yields, while the structural story remains strong with rising levels of urbanisation, industrialisation, positive demographics and increasing levels of investment in infrastructure all contributing to long-term economic growth in the region.

But Asian equity income is a higher-risk option as this area includes a number of emerging markets, which are potentially more volatile and higher risk. Australian shares are also commonly included in Asian equity income funds, but as this is a mining and resources influenced economy heavily linked to the fortunes of the Chinese economy, these could prove volatile. Henderson expects cuts from oil and mining companies to take 12 per cent off Australian payouts this year.

A good way to access Asian equity income has been Schroder Oriental Income (SOI), an investment trust we count among our IC Top 100 Funds. This has outperformed MSCI AC Asia Pacific ex Japan Index over one, three and five years, both in terms of its net asset value (NAV) and share price total return. It also beats its income focused sector peers, Aberdeen Asian Income Fund (AAIF) and Henderson Far East Income (HFEL), over these periods.

The trust aims for attractive income and income growth potential, and has grown its dividend every year since launch in 2005. Schroder Oriental Income yields 4.3 per cent.

The trust is run by a highly experienced manager, Matthew Dobbs, who has been investing in Asia for 29 years. He favours companies with visible and sustainable growth, sound balance sheets and good corporate management.

Schroder Oriental Income has about a quarter of its assets in Hong Kong listed companies, and nearly as much in Australia.

The trust is trading at a discount to NAV of about 0.8 per cent. Because of its attractive yield this trust sometimes trades at a premium so just now could be a good entry point.

Asian equity income investment trusts

Source: Winterflood at 13 June 2016

*Association of Investment Companies