The perils of relying on FTSE 100 in your search for income

Darius McDermott, managing director of Chelsea Financial Services, looks at the benefits of diversification in stock outside of the FTSE 100 for income.

The perils of relying on FTSE 100 in your search for income

Disappointing news from AstraZeneca, British American Tobacco and Imperial Brands serves as yet another reminder of the perils of relying on the dividends of a handful of UK large caps.

AstraZeneca’s shares fell 15% on 27 July after the pharma giant told investors that trials of a lung cancer treatment had not met expectations. Just one day later, British American Tobacco and Imperial Brands experienced share price falls of 7% and 4% respectively[1]. This was sparked by the US Food and Drug Administration’s announcement that it plans to lower nicotine levels in cigarettes to non-addictive levels.

Although these announcements are yet to impact prospective dividends for the three large caps, the repercussions will be felt by many well-known UK equity income fund managers who hold the stocks in their top 10.

Diversifying your income exposure outside of the FTSE 100 offers many advantages. Firstly, it means your income stream is less vulnerable to any high profile dividend cuts. Secondly, you can gain access to exciting small and mid caps which have a strong track record of growing their dividends.

Marlborough Multi Cap Income is a prime example. Close to 73% of the portfolio is in small and mid caps, reflecting manager Siddarth Chand Lall’s belief that the best opportunities lie outside of the FTSE 100[2]. This approach has paid off over the past five years, evidenced by an impressive return of 106.9%. This compares to a gain of 69.5% by the average fund in the Investment Association’s (IA) UK Equity Income sector[3]. The fund has a healthy yield of 4.1% to boot[4].

There’s also something to be said for venturing outside of the UK for income. Across the channel, investors can get access to a number of stable dividend payers. The MSCI Europe ex-UK index yielded 3.1% at the end of June. This compares to an average yield of 1.9% for the S&P 500 and 3.6% for the UK FTSE All-Share[5].

Our top pick in Europe is BlackRock Continental European Income. Fund managers Alice Gaskell and Andreas Zollinger seek out undervalued stocks, which have the potential to sustain and grow their dividends. Over the past five years, the fund has returned 130.4%, ahead of a gain of 106.1% by the average fund in the IA Europe excluding UK sector[6]. BlackRock Continental European Income has a yield of around 3.9%[7].

Asia has also become an attractive home for income-seekers, as a result of corporate governance improvements across the region. Companies have become accustomed to paying out dividends and have the potential to grow these over time. A number of countries across Asia enjoy higher economic growth rates than some developed markets, supported by positive demographics and the rise of domestic consumption.

I would highlight Schroder Asian Income as one to consider in this space. Manager Richard Sennitt focuses on attractively valued companies with sustainable dividends. Over the past five years, the fund has returned 81.3% versus 73.3% by the IA Asia Pacific excluding Japan sector average[8].

The US and Japan are lower yielding markets in comparison to the UK, Europe and other parts of Asia, so they may be less appropriate for yield-hungry investors.

If you are not looking to allocate to income funds on a regional basis, a global income fund could provide a solution. The Fidelity Global Dividend fund is one to consider, up 100.4% over five years versus 75.4% by the IA Global Equity Income sector average[9]. It has a historic yield of 2.8%[10].

It is also worth thinking about whether you want exposure to different currencies in your portfolio. If you prefer to keep your investments in your home currency, it is best to go for a ‘hedged’ sterling share class.

Investors must be careful not to rely on an over-owned set of UK dividend payers. The time could be ripe to look overseas.

 

[1]      Source: Google Finance, 27 and 28 July 2017

[2]     Source: Marlborough Multi Cap Income fact sheet, August 2017

[3]     Source: FE Analytics, total returns in sterling, 8 August 2012 to 8 August 2017

[4]     Source: Marlborough Multi Cap Income fact sheet, August 2017

[5]      Source: JPMorgan Asset Management, Guide to markets, 30 June 2017

[6]     Source: FE Analytics, total returns in sterling, 8 August 2012 to 8 August 2017

[7]     Source: BlackRock website, BlackRock Continental European Income ‘key facts’

[8] Source: FE Analytics, total returns in sterling, 8 August 2012 to 8 August 2017

[9]  Source: FE Analytics, total returns in sterling, 8 August 2012 to 8 August 2017

[10] Source: Fidelity Global Dividend fact sheet, 30 June 2017

 

Please remember, no news or research item is a recommendation or advice to buy. Every Investor is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest and tax policies may change. 

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