Interest rates are at a record low, and likely to stay that way until next year at least. Yields on most government and high-grade corporate bonds are also well below their historic average, and the risks of holding them are rising. It is, therefore, unsurprising that investors looking for income should be attracted to other assets and, with a growing number of companies offering apparently attractive dividend yields, the stock market can seem an obvious place to turn.
But, as many investors have found out to their cost in recent months, dividends are not guaranteed. Some of Britain’s biggest companies – including Tesco, Sainsbury’s, Standard Chartered, Centrica and Anglo American – have already cut their payments and Capita Asset Services, which produces a quarterly Dividend Monitor, warns that there could be more cuts to come. It forecasts that total dividends for UK plc will fall by 1.3% to £86.5 billion in 2016.
Seeking a sustainable dividend
“The picture for dividends is very mixed,” says a Capita spokesman. “Indeed, we are far less certain about the outcome for the year ahead than we have been for several years. Some very large UK-listed firms have slashed their payments lately and there may be more bad news to come. Meanwhile, currency effects continue to add considerable volatility to UK payments.”
It is vital to understand the risks of buying high-yield companies for income. The first thing to consider is whether the dividend is sustainable: a high yield can often reflect the market’s expectation that a dividend will be cut – for example it might be the result of a share price slump, which leaves the dividend looking attractive but only because the market has repriced the stock.
Then there is the risk of concentrating your investment in just a few sectors. Capita research shows that, in 2015, just 15 companies accounted for 55% of total dividends from British companies. A third of them were from the oil and mining sectors, where falling prices have increased the risk of cuts. A decade ago, the top rank of dividend payers was dominated by banks, many of which cut, or even abandoned, their payments during the financial crisis.
Will Meadon, Fund Manager of JPMorgan Claverhouse Investment Trust, points out that even if the large oil companies maintain their payments this year, they will have to borrow money to do so, thereby potentially weakening their position. “Rather than depend on such risky stocks, investors should instead focus on stocks with lower yields but which have a greater certainty of dividends being paid or – better still – increasing,” he says. Among the sectors he recommends are housebuilders and tobacco companies.
Foreign exchange fluctuations
Third, there is currency risk. Rob Burgeman, Investment Manager at Brewin Dolphin, points out that many of the biggest companies – including HSBC, BP and GlaxoSmithKline – declare their dividends in dollars. That has worked in investors’ favour in recent years as sterling has weakened against the dollar. Should that reverse, however, the actual amounts that UK investors receive would be reduced by exchange fluctuations.
Burgeman says that a diversified portfolio, spread across a range of different shares and different types of assets is essential. “It is impossible to predict which income stream will falter,” he says, “but I can predict that some will over the next 15 years.” Investing via collective funds will not necessarily produce that diversification, he adds, as many of these funds will have holdings in the same companies.
He also points out that many international companies offer good levels of income, which can also be accessed via global income funds. “The UK stock market is very concentrated: five years ago, more than a fifth of it was made up of oil and mining stocks,” he says. “If you had unwittingly followed the herd into these companies, you would have had a very bumpy ride indeed.”
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