Finding attractive and safe income streams from UK equities is becoming fraught with difficulty. Our blue chips were once lauded for their stability, coupled with an ability to throw off fat dividend payouts, and many saw them as the mainstay of any global equity-income portfolio. However, there is a growing wariness about the outlook for UK equity income and increasingly investors are looking overseas for solid income-generating stocks.
A key problem with the UK equity-income scene is the reliance on just a handful of blue-chip stocks to produce most of the income being generated by equities. Indeed, 10 companies account for about 60 per cent of income from the FTSE 100 and five account for 45 per cent. This kind of concentration of income-producing shares is hardly conducive to diversifying risk. And many investors who hold high-yielding UK equity income funds are exposed to the market's reliance on a small group of shares to fulfil its income needs.
What was a bad situation has been made worse by the credit crunch. Many blue-chip financials, which were previously some of the index's big income plays, pulled or cut dividends, which has left UK equity income hunters relying on just a handful of sectors, such as pharmaceuticals, utilities and oil & gas.
The risk of being corralled into such a narrow corner of the market has been made abundantly clear by the BP Gulf of Mexico oil spill disaster and the suspension of the dividend. Given that BP had, until recently, accounted for over 12 per cent of the income from the FTSE 100, many private investors, large UK equity income funds and pension funds had counted on its payouts.
Analysts are now forecasting that dividend growth will re-emerge in the UK, but with much of the global economy still in the doldrums, the rate of growth may be sluggish for some time to come. Indeed, international fiscal tightening is hardly conducive to prospects. Arguably, small-cap UK equity income offers greater potential for dividend growth.
However, small caps are more reliant on the UK economy than blue chips and there are fears our recovery, if it can be sustained, will be among the least impressive in the West. What's more, small companies do not offer the same perceived safety as blue chips, although diversity can go a long way to offsetting a BP-type crisis.
All in all, perhaps it's time investors started to look outside the UK to more promising overseas markets for income. Investment trusts provide an easy route into what can be unfamiliar territory and instant expertise at the hands of the right fund manager. There are many very attractive trusts out there offering interesting perspectives on their chosen markets.
What's more, because investment trusts are structured as companies they are able to accumulate reserves on their balance sheets and can therefore pay dividends from these reserves even if the income being generated from the underlying portfolio temporarily falls short.
