Bond yields have recently collapsed, in some cases turning negative, meaning that a good income is harder to come by So if you want a meaningful income, you have to invest in riskier types of debt such as high-yield or emerging market bonds.
But investors have another option – equity income. Even though equity prices have risen substantially in recent years, pushing down yields, established companies around the world remain focused on increasing or at least maintaining the dividends they pay. As we noted in Look to equity income for growth with less downside risk, in the issue of 6 September, an equity income strategy can mean investing in companies with a more defensive approach in unpredictable times.
But you still need to take on some risk for this income – equity market volatility and company-specific problems can threaten dividends and total returns.
Recent difficult conditions have also been a drag on dividend growth. In November, the Janus Henderson Global Dividend Index reported global headline dividend growth of 2.8 per cent in the third quarter of 2019. But the report also cautioned that a spurt of dividend growth witnessed in recent years was likely to stall, in part due to subdued economic activity feeding into corporate balance sheets.
“A slowdown in global dividend growth, more in line with long-term trends, is under way,” said the report's authors. “We have been cautioning investors all year that the rapid income growth they have enjoyed over the past couple of years is set to return to more normal levels. A softening global economy is beginning to have an impact on corporate earnings and, in turn, on dividends.”
So if you invest in equity income you need to diversify across funds and regions, as well as individual companies. But making the right selection is far from straightforward.
Equity income by region
The table below gives a flavour of the options available by detailing how many income-focused open and closed-ended funds are available within the relevant Investment Association (IA) and Association of Investment Companies (AIC) sectors. To give an idea of the sort of income they can generate, we have listed both the highest yield on offer and the average at the time of my analysis. We have not included small and mid-cap fund sectors because few funds focused on those areas have an explicit income mandate.
Region | Average equity income fund yield (%) | Highest yield on offer (%) | Number of explicitly income-focused equity funds |
Asia | 4.6 | 7 | 11 |
UK | 4.5 | 7 | 90 |
Europe | 3.9 | 6 | 12 |
Emerging markets | 3.5 | 4.3 | 9 |
Global | 3.3 | 8.3 | 65 |
Japan | 2.5 | 3 | 4 |
US | 2.3 | 5 | 15 |
Source: FE, 03/01/2020
Although this is only a snapshot, it outlines what is on offer in different regions. Your allocation to specific areas will vary depending on your outlook, risk appetite and what is complementary to the rest of your portfolio.
In terms of the average and highest yield on offer at the beginning of 2020, equity income funds in Asia and the UK stand out. Each offers an average yield of around 4.5 per cent, with the highest level of income currently amounting to a substantial 7 per cent. However, there are issues to be aware of in both regions.
The dividend-rich UK market, which is still on relatively low valuations amid Brexit uncertainty, was forecast to yield 4.7 per cent in 2020 as of mid-December by broker AJ Bell. But popular as the UK market is with investors for both its attractive yield and currency factors, it remains beholden to the fortunes of a small number of dividend-payers who could cut or fail to grow their payouts.
For example, Vodafone (VOD), one of the larger dividend payers in the market, cut its full-year dividend by 40 per cent in 2019 as it looked to bolster its balance sheet. Marks & Spencer (MKS) also announced a dividend cut last year.
This problem has not gone away: in its latest Dividend Dashboard report in December, AJ Bell noted that just 10 stocks were expected to generate more than 98 per cent of 2020’s forecast £1.6bn increase in total dividend payments from the FTSE 100. The average earnings cover ratio – or the degree to which companies’ dividends were covered by their profits – was expected to come to 1.69. AJ Bell said this was “still some way below the 2.0 threshold that gives comfort and provides a safety buffer, should anything untoward happen”.
Brexit uncertainties will affect dividends and overall performance in more ways than one. The progress of the UK’s departure negotiations will have an impact on business confidence, how some dividend-payers fare, and on share price performance and dividend payments in different parts of the market. For example, if a smooth Brexit boosts domestic-orientated companies, the same scenario could simultaneously have a negative effect on bigger, more international businesses if it leads to a stronger sterling and diminishes the value of overseas earnings and dividends.
Some funds have been generating extremely high yields. For example, Schroder Income Maximiser (GB00BDD2F083) yielded 7 per cent at the time of our analysis, and Fidelity Enhanced Income (GB00B87HPZ94) and BNY Mellon Equity Income Booster (GB00B8HCF105) were at a similar level. However, these can sell call options on certain holdings to other investors who can effectively borrow stocks from them. This means that these funds may sacrifice some capital growth in exchange for a higher income, and currently they lag the FTSE All-Share index and the IA UK Equity Income sector average total return over one, three and five years, albeit with positive returns.
If you have more modest income requirements, or want to put more emphasis on total returns, a fund that is diversified across different sectors and company sizes would be a good option. Royal London UK Equity Income (GB00B3M9JJ78) invests across the market, including in to mid-caps which could benefit from any improvements in the Brexit outlook and the domestic economy. And Man GLG UK Income (GB00B0117D35) strongly outperforms the FTSE All-Share index and the IA UK Equity Income sector average over one, three and five years. It has a yield of around 5 per cent and is diversified across the UK market.
Dividends also look attractive in Asia, but political shifts and other developments could result in volatility. The Janus Henderson Global Dividend Index report said that there had been “distinct signs of weakness” in China in the third quarter of 2019, with half of the Chinese companies included in its analysis reducing their payouts as slowing economic growth took its toll. And the ups and downs of the US/China trade war could mean an unpredictable environment for such companies. But if the trade war eases, as it has recently appeared to, Chinese businesses could look more stable.
A fund that sells call options – Schroder Asian Income Maximiser (GB00BDD29F14) – offers the highest yield among funds focused on this region. Guinness Asian Equity Income (IE00BDHSRF15) offers a yield of 4 per cent, and also looks for capital growth via a process that has produced strong total returns over one, three and five years.
Analysts at investment platform Interactive Investor note that its managers look for quality, value and dividends in their prospective holdings. “They focus on profitable companies that have generated persistently high returns on capital, and demonstrated stability and resilience over an eight-year period," add the analysts. "Companies whose shares underprice the likely persistence of those returns, and that can grow their dividends."
This fund's allocation is significantly different from that of major Asian indices, giving it scope for outperformance. However, it is highly concentrated, with just 36 holdings, elevating both its potential risks and rewards.
Unloved opportunities
Stagnant growth and political difficulties have steered many investors away from continental Europe in recent years. Similarly, allocating to emerging market equities has proved disappointing for many investors, particularly as trade war and growth concerns weigh on investor sentiment. But some funds focused on these regions have still managed to eke out attractive yields.
BlackRock Continental European Income (GB00B3Y7MQ71), for example, yields around 3.7 per cent and its total returns also hold up relatively well. Analysts at fund ratings agency FundCalibre note that an experienced team works together to run a fund that “pays an above-average yield with below-average volatility”. The team focuses on fundamental company analysis when choosing holdings, but maintains a “strong awareness” of macroeconomic trends. The fund is flexible when it comes to company and country exposures, and can deviate from its benchmark, FTSE All World Developed Europe Ex UK Index, when required. The fund’s manager, Andreas Zoellinger, looks to find a balance of companies with large, but secure, dividends and those that can grow their dividends faster than the average business.
Although emerging markets can be volatile, some funds that invest in these have provided reliable income and total returns over the years. JPM Emerging Markets Income (GB00B5N1BC33) has a yield approaching 4 per cent, but also tends to perform well versus its benchmark, MSCI Emerging Markets index, and other funds focused on the region. However, as with some Asian and US funds, it holds some businesses that may be unduly affected by any trade war developments. The fund had a 30.5 per cent allocation to China at the end of November, with tech names Taiwan Semiconductor Manufacturing (TAI:2330) and Samsung Electronics (SMSD) among its top holdings.
As it is more growth-focused, the US is generally less appealing for income, and most of the North America funds in our sample yielded less than 3 per cent. And the few income-oriented Japan funds pay yields of between 2.3 and 3 per cent. But corporate reforms under way in Japan should gradually translate into dividend growth, so it may be worth considering an allocation to strong performers such as Baillie Gifford Japanese Income Growth (GB00BYZJQG71), which could benefit from eventual improvements.
If you are looking for a simpler route to diversification or for yield, you should also consider global equity funds with an income remit. However, when using global funds, or any approach that involves mixing regions, and income funds with growth ones, remember to check whether your selection duplicates exposures to specific companies, sectors and geographies.
Some of the higher-yielding funds in the IA Global sector focus on infrastructure equities, including Legg Mason RARE Global Infrastructure Income (GB00BZ01WT03) and Premier Global Infrastructure Income (GB0031637738). These can provide a good income but may be too specialist an approach for some investors.
If you want a more generalist fund, Janus Henderson Global Equity Income (GB0031263899) might appeal. The fund has lagged some of its peers lately because its focus on dividend-paying companies has led it away from the US, which continued to lead equity market returns last year and is a significant allocation of many global funds. But it has a yield of around 3.8 per cent and its focus on other parts of the world may help to diversify growth-oriented US allocations.
Fund/benchmark | 1-year total return (%) | 3-year cumulative total return (%) | 5-year cumulative total return (%) | 10-year cumulative total return (%) |
BNY Mellon Equity Income Booster | 14.19 | 12.98 | 29.04 | 105.79 |
Fidelity Enhanced Income | 18.84 | 13.48 | 24.82 | 94.49 |
Man GLG UK Income | 21.76 | 43.88 | 71.02 | 163.27 |
Royal London UK Equity Income | 23.89 | 26.21 | 47.74 | 200.18 |
Schroder Income Maximiser | 9.41 | 16.57 | 31.96 | 111.89 |
IA UK Equity Income sector average | 20.07 | 19.58 | 38.22 | 126.44 |
FTSE All Share index | 19.17 | 22.01 | 43.84 | 118.28 |
Schroder Asian Income Maximiser | 9.37 | 20 | 50.01 | |
Guinness Asian Equity Income | 14.42 | 28.09 | 66.14 | |
IA Asia Pacific Excluding Japan sector average | 15.78 | 30.89 | 58.97 | 110.52 |
MSCI AC Asia ex Japan index | 13.61 | 33.75 | 61.65 | 118.88 |
BlackRock Continental European Income | 20.26 | 27.4 | 63.17 | |
IA Europe ex UK sector average | 20.33 | 23.97 | 57.7 | 115 |
FTSE Developed Europe ex UK index | 19.46 | 25.2 | 56.05 | 99.83 |
JPM Emerging Markets Income | 17.94 | 30.85 | 52.62 | |
IA Global Emerging Markets sector average | 16.04 | 27.39 | 49.68 | 67.76 |
MSCI Emerging Markets index | 13.86 | 29.55 | 54.65 | 74.93 |
Baillie Gifford Japanese Income Growth | 15.86 | 30.41 | ||
IA Japan sector average | 17.22 | 22.46 | 74.69 | 141.23 |
TSE TOPIX index | 15.76 | 22.33 | 78.39 | 144.17 |
Legg Mason IF RARE Global Infrastructure Income | 26.93 | 35.95 | ||
Premier Global Infrastructure Income | 20.43 | 15.54 | 44.53 | |
Janus Henderson Global Equity Income | 16.85 | 20.46 | 57.81 | |
IA Global Equity Income sector average | 18.63 | 23.29 | 54.24 | 143.42 |
MSCI World index | 22.74 | 33.06 | 78.95 | 201.24 |
Source: FE, as at 31/12/2019