Income investing: avoid being painted into a corner
Over 60% of market income in the FTSE All-Share is paid by the top 20 companies
It became clear recently that UK-focused income investors are at an even greater risk of painting themselves into a proverbial (low-yielding) corner. The recent announcement that dividend stalwart Vodafone will be slashing its distribution to shareholders by 40% is not great news for those investors who have typically relied on allocating domestically for an income return.
There have been several reasons cited for Vodafone’s switch to a more restrained payout. Fears about servicing its mounting debt levels as well as the acknowledgement of increasingly tougher operating conditions have undoubtedly weighed on the minds of the telecom company’s board. And perhaps the same kind of reality check will now also be passed to investors in UK firms.
The problem is that the available income stream to investors in the UK stock market is becoming ever-more concentrated. Over 60% of market income in the FTSE All-Share is paid by the top 20 companies. This means that when one or more of these income big-hitters reduces its dividend, either by choice or necessity, the impact on UK-focused investors can be substantial.*
Yield concentration of top 20 stocks
Source: Bloomberg, as at 31 March 2019
What’s more, a significant number of these 20 companies are cyclical, with oil and gas, mining and banks producing a sizeable proportion of the income stream. This extra layer of concentration leaves investors doubly vulnerable. Commodity weakness for instance, could easily see dividends once again exposed by poor earnings and cashflows, leaving the UK investor open to the risk of further dividend cuts. In addition, news of plans by the Labour Party to nationalise the UK’s energy network (should it take office), would also mean the available income stream to UK investors becoming ever-more limited as utility firms are brought back into public ownership.
Of course, the answer to mitigating this kind of concentration risk is a simple one, but often clouded by the irrational home bias that creeps into investor mindsets. By investing globally, it is possible to diversify portfolios and avoid the risks inherent in single-country exposure. But not only that, by doing so also opens up the investible universe and provides access to some of the best companies in the world, regardless of sector or location.
Look at the giants of the technology sector and some of the biggest dividend growth stories in recent times: Apple (US), Taiwan Semiconductor (Taiwan) and Samsung (Korea) to name just a few. To have rigidly invested exclusively in UK funds would have been to miss the chance to access the extraordinary growth of these companies.
A timely reminder
We believe the Vodafone announcement should serve as a timely reminder of the fragility of dividend sustainability. It is also entirely possible that other once-reliable dividend-paying UK companies may follow suit in the months ahead. The uncertainty of Brexit as well as the impact of lacklustre levels of growth putting pressure on cash flows may shortly force many other firms to shift their stance on payouts. Even more reason, we believe, to look for cash-generative business elsewhere by taking a global approach to income investing.
*Source: Bloomberg, as at 31 March 2019
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