Look across the world for plentiful income opportunities

But if you are seeking a healthy income, the good news is that there are still plenty of opportunities outside of the UK. Across the globe, dividend payouts grew by an average of 9.2 per cent during the third quarter of 2018, according to the Janus Henderson Global Dividend index. This represented a 5.1 per cent increase year on year, with payments totalling $354.2bn (£280.66bn) – a third-quarter record.

Emerging markets were a key contributor between July and September, with underlying dividend growth of 15.7 per cent, while Europe excluding UK experienced growth of 9.1 per cent, and North America 7.6 per cent. By contrast, a weakening pound and lower special dividends resulted in headline dividend growth of only 3 per cent in the UK over the same period.

Also, although the home market has an established dividend culture, investors typically rely on high payouts from a few large companies. For example, five of the UK’s largest listed companies accounted for 40 per cent of total dividend payments across the market during the third quarter of 2018, according to the Link Asset Services UK Dividend Monitor.

Diversification benefits

Investing overseas for equity income is an opportunity to diversify your portfolio, generate attractive returns and grow your income stream over time. Peter Lowman, chief investment officer at wealth manager Investment Quorum, believes that this is particularly appealing at a time when the UK stock market faces great uncertainty as a result of Brexit.

“While the UK remains one of the strongest equity income regions, having global diversification is no bad thing,” he says.“Investing globally gives you the opportunity to capture higher risk-adjusted returns, and income investors can benefit from rising dividend growth in regions such as Asia and the emerging markets [where there are opportunities for long-term investors]."

What’s more, investors can capitalise on cheap valuations following recent global stock market corrections. 

Daniel Lockyer, co-head of fund management at Hawksmoor Investment Management, agrees that investing overseas for income can provide investors with the scope to generate attractive returns. It also means that they are not solely reliant on the UK to deliver capital growth or income.

Diversification is often described as 'the only free lunch in town', and this certainly seems to be the case with equity income investing. Gaining exposure to different countries and currencies can potentially reduce risk and volatility within a portfolio.

“We recognise that most UK investors have investments that ideally would match their liabilities," says Mr Lockyer. "If you have bills to pay, you want to make sure the income you receive is in the same currency, a reason for the home bias. However, we think there are benefits in investing further afield which compensate you for the potential risk of having a currency mismatch."

Currency risk

When investing overseas you need to think carefully about the currency risk that you are taking on in your portfolio. It isn’t simply a case of deciding whether valuations look attractive – you must also consider whether it would be beneficial to gain exposure to other currencies. And currency issues need to be monitored on an ongoing basis because the outlook for a currency can change rapidly, complicating matters further.

Nathan Sweeney, senior investment manager at asset manager Architas, urges investors to think about “both sides of the trade”. This is because it isn’t simply a case of deciding whether sterling has the potential to rise or fall, you also need to consider the outlook for the other currencies you are seeking exposure to.

If you invest in a global equity income or regional equity income fund, you typically have the option to invest via a hedged or unhedged share class. A hedged share class eliminates currency risk by hedging any currency exposure back to sterling. However, if sterling depreciates you will miss out on that kicker from the underlying currency. But if sterling appreciates and you have not opted for a hedged share class, this could wipe out some of your gains.

At the moment, when deciding whether to gain exposure to a dollar-denominated global equity income fund or to hedge back to sterling, there are numerous factors to consider.

Firstly, there is the potential impact of Brexit. Although the pound has depreciated significantly against the dollar since the UK voted to leave the EU in June 2016, the direction of travel for the currency remains unclear. In the event of a ‘hard Brexit’ or no deal, which would see the UK give up full access to the single market and customs union, sterling would potentially depreciate further. But if there is a ‘soft Brexit’, meaning that the UK retains close ties with the EU, sterling could appreciate sharply.

The dollar, meanwhile, has strengthened relative to sterling over the past year. But the US central bank, the Federal Reserve, has indicated that the pace of interest rate hikes may slow in 2019, which could put downward pressure on the currency. And there are other factors at work. For example, if trade tensions start to cool with China, this will have implications for the dollar, so making a call on currency is by no means clear cut.

It’s also important to consider the costs of hedging. This can be particularly expensive if you are hedging back to sterling from a higher-yielding currency.

“The cost of hedging between sterling and the dollar could be 2 per cent," explains Mr Sweeney. "This brings in a secondary consideration: if you are looking to invest for income, you need to make sure the level of income is high enough to compensate you for the cost of hedging."

Global versus regional

You can get exposure to international dividend payers via global equity income or regional funds. Opting for a global income fund means you are delegating the decision on geographical allocation to its manager, but you should still monitor the fund to ensure it provides genuine diversification.

The alternative is to invest in a few regional equity income funds that give exposure to regions where you have spotted investment opportunities. This approach allows you to tap into local expertise and have more control over specific geographical allocations. With this approach it is important to consider whether the regional equity income funds you are thinking of investing in provide the geographical diversification you require.

Mr Lockyer likes to hold both global and regional equity income funds. He typically invests in global equity income funds that have a bias to high-quality companies, and alongside these holds regional equity funds that provide exposure to dividend growth in Asian, emerging and frontier markets. 

Examples of regional funds he likes include Jupiter Emerging & Frontier Income Trust (JEFI), which he says is a good way to access attractive yields in emerging and frontier markets. Emerging markets have had a difficult 12 months, meaning this investment trust, which launched in May 2017, has got off to a slow start in terms of performance. But Mr Lockyer believes there is a case for getting exposure to the themes of improving corporate governance and dividend growth, as a growing number of companies across these markets become more shareholder friendly.

Managed by Ross Teverson, this investment trust is trading on a discount to net asset value of around 3.4 per cent and has a yield of about 6 per cent. It invests in companies listed in countries such as Taiwan, Brazil, Russia and Nigeria.

Japan is another market where investors can tap into improving corporate governance and a growing dividend culture. For example, the JPX-Nikkei Index 400, which was set up a few years ago, only includes companies with high return on equity.

“Many companies on the Japanese stock market have very low gearing and strong balance sheets, yet their payout ratio is very low,” adds Mr Lockyer.

This underscores the potential for dividend growth to come through across this market. Mr Lockyer says a good way to get exposure to this is Baillie Gifford Japanese Income Growth Fund (GB00BYZJQG71). Its managers, Matthew Brett and Karen See, aim to invest in companies that have competitive advantages. Although the fund’s yield is relatively low at 2 per cent, Mr Lockyer says income growth is likely to come through in time.

Global equity income funds

If you would prefer to get overseas income via a global fund, options include Newton Global Income (GB00BLG2W887). Its manager, Nick Clay, targets companies from around the world with a dividend yield that is at least 25 per cent higher than the world market and the fund has a yield of about 3 per cent. Newton Global Income focuses on quality companies, which are attractively valued and able to generate sustainable dividends, meaning the fund tends to hold up well in volatile markets.

Guinness Global Equity Income (IE00BVYPP131) is a good option for dividend growth potential. Its managers, Matthew Page and Ian Mortimer, invest in quality companies that are attractively valued, have delivered high returns on cash over the past 10 years and have the potential to do this in the future. Mr Lockyer says that although the fund’s yield is only around 2.7 per cent its managers have a strong record of growing its income stream over time.