Time to go global for income?

One key appeal of dividend income is that it pays investors to be patient as share prices fall, and it makes up a large proportion of investment returns over decades. “However, over the past five years, dividend investing has been somewhat overlooked as investors focused on exciting high growth technology stocks driving stock market returns,” notes Gavin Haynes, an investment consultant at Fairview Investing. 

The MSCI World High Dividend Index has significantly underperformed the wider MSCI World Index over the past five years, returning 30.4 per cent compared with 44.7 per cent. Over the past 20 years, though, dividend income makes up about 40 per cent of total returns from the MSCI World Index. 

Equity income was once a stalwart of investors’ individual savings account (Isa) and pension portfolios because of its combination of income and capital return. However, over recent years the sector suffered as companies cut their dividends during the Covid-19 pandemic. Investments providing dividend income also faced other issues, such as Brexit uncertainty, the high-profile failure of Neil Woodford’s enormous equity income fund, as well as the move towards turbo-charged tech ‘growth’ stocks. 

Now, though, the tide seems to be turning in favour of income-seeking investors once again, against a challenging economic backdrop and the increased risk this entails for stock markets. 

In particular, the UK has proved a fertile hunting ground for income-seeking investors, and a large majority of FTSE 100 index stocks are expected to pay dividends in 2022. The UK has long been recognised as a mature, dividend-producing market, with one of the highest dividend levels in the world. 

The FTSE 100 dividend yield stood at about 3.6 per cent at the end of June, which is greater than the majority of other global markets; in contrast the S&P 500 yields around 1.6 per cent, with a market that is far more focused on growth. “While the UK market’s yield is lower than the current rate of inflation, it remains competitive when compared with other sources of income such as government bonds and cash,” says Tom Stevenson, investment director at Fidelity International. 

Haynes stresses that UK valuations remain relatively cheap, and that plenty of blue-chip dividend payers are globally diversified businesses. The FTSE is rich in stocks across areas such as oil, mining, pharmaceuticals, banks and utilities, all of which are well placed to offer attractive dividends. 

However, the growth of global markets over the past few decades has produced a rising number of high-yielding investment opportunities. Shifting demographics, as populations age around the world, have increased demand for companies to offer income-generating assets and commit to growing dividends. 

Meanwhile, UK dividends may face headwinds during the anticipated economic downturn. Stevenson says: “The UK may be more exposed than other countries to stagflation and recession risks due to low productivity growth, weak sterling and the impact on the labour market of Brexit. This may limit the future growth of dividends in the UK.”

Fortunately, there are plenty of UK and global equity income funds that enable managers to cast their nets out to a wide range of companies around the world for dividend and growth potential. If you are able, holding both UK and globally focused assets within a diversified portfolio may be sensible. 

Broadly diversified global equity income funds largely tend to concentrate on developed markets where there is an established culture of companies paying dividends. However, there are also funds and trusts focusing on dividend payers in Asian and emerging markets, so you can diversify both sectors and geographical regions. 

Besides, diversifying equity income exposure makes good sense when a large proportion of dividends generated from the UK stock market are concentrated in a small number of stocks and sectors. While the UK market provides attractive dividends, many income-paying sectors are mature, large businesses that don’t have the growth opportunities available to other sectors in global equity income trusts. 

Taking a global approach can provide a significantly wider universe of income-producing stocks. Since 2010, global dividends have grown at 8.3 per cent a year, according to figures from Henderson International Income Trust (HINT). The latest Janus Henderson Global Dividend Index report found that global dividends grew by a record 11 per cent over the first quarter of 2022, on the back of economic recovery after the pandemic, although global uncertainty means the forecast for 2022 as a whole stands at 4.6 per cent. Moreover, over recent years sterling’s weakness and economic headwinds in the UK have improved the profits and dividends of global companies compared with UK dividend payers.

However, Ian Milward, of independent financial adviser Candid Financial Advice, cautions: "The secret, as ever, lies in balance. There is nothing wrong with including global income funds as a small part of your portfolio, but they are not a holy grail, so you should not be repositioning your portfolio in pursuit of this. Even if you need income from your portfolio, it is too narrow and skews you towards certain sectors.” He suggests 10 per cent of a total portfolio is invested in equity income funds or trusts, and favours trackers as a core holding with select, active funds added to this. 

Certainly, it seems that investors are keen to take advantage of this, pouring more than £1.5bn into global equity income funds over the past year, with the overwhelming majority of investments made in the six months to end of April, according to the Investment Association (IA). 

As with any investment, it’s important to consider your risk tolerance when choosing an equity income fund. While some managers focus mainly on small- and mid-cap stocks, others choose larger companies, so it’s vital to know what you’re buying by looking under the bonnet. Beware, too, that some of the markets that global income funds invest in can be particularly volatile. 

Dzmitry Lipski, head of fund research at interactive investor, says: “Investors should take a balanced approach to equity income, giving preference to global stocks with moderate but rising dividends and strong balance sheets, instead of just high dividend payers. 

“More adventurous investors could look beyond traditional asset classes to take advantage of more attractive income opportunities that exist across global markets. Emerging markets and high-yield bonds could offer higher yields, for example, but this means taking on more risk.”

Investors seeking UK equity income exposure could consider the Vanguard FTSE UK Equity Income index fund (GB00B5B74684), recommended by Lipski, which provides broader income exposure to the UK market by tracking the FTSE UK Equity Income Index of more than 100 highest dividend-paying shares. As the fund is spread across a wide variety of sectors, there is already some diversification.  

Haynes recommends Merchants Investment Trust for exposure to UK dividend stocks, with a current yield of 4.8 per cent and a focused portfolio of sold, blue-chip stocks that the managers believe to be quality businesses that are currently undervalued. 

Turning to global dividends, Murray International Investment Trust comes with a yield of 4.2 per cent and a 17-year record of rising dividends. Its manager aims to generate long-term capital growth alongside better-than-average dividend yields from a global portfolio of bonds and equities. The trust has half its portfolio in Asia Pacific ex-Japan, Latin America and other emerging markets, where  dividends – and risks – are often higher.  

However, equity income investment trusts are in some cases trading at a small premium or close to the value of their underlying assets. By contrast, the average investment trust is currently on a discount of 9 per cent. Lipski says: “Equity income investment trusts remain in demand among yield-hungry investors looking for quality growth and income – and the investment trust sector has that in spades. So we wouldn’t dwell on modest premiums or trusts trading at around net asset value, but it can be worth keeping an eye out for discount opportunities in the current volatile markets. However, long-term investors need not focus on finding discounts.”

The good news for those investors looking for income is that there is still plenty of it about, despite equity income being out of favour in recent years. Its appeal lies not just in the income offered by the underlying investments, but in the potential for dividend reinvestment to boost your capital base, as well as for the managers to grow your capital over time. 

Remember that equity income funds and trusts aren’t risk-free bets that are guaranteed to offer returns during the current turbulence – but they can provide some much-needed diversification during troubled times. Ultimately, both UK and global dividend payers deserve a place in a balanced portfolio.