New year: New threats or new opportunities for UK equity income?

New year: New threats or new opportunities for UK equity income?

A strong decade for UK equities: Will this continue?

As we enter a new decade, it is useful to remember how good the returns were from investing in UK equities in the 2010s than the previous one. The FTSE All-Share Index more than doubled, returning 118% comfortably, eclipsing inflation over the period which was cumulatively around 23%.[1] Furthermore, annual dividends paid out by UK companies more than doubled in the last ten years to over £100 billion. The FTSE All-Share Index finished the decade yielding over 4%. However, the question on most investors’ minds is can we expect more of the same?

The potential for attractive opportunities in a discounted environment

On a positive note UK equity valuations stand at a discount to their international peer group, the pound lost ground to major rivals in the last ten years and certain sectors within UK stock market have acquired almost pariah status due to the tortuous Brexit process. It would be incorrect to argue that UK equities are cheap relative to their own history, with valuations a bit above their long-term average. However, the UK stock market stands at a substantial discount to international peers and looks good value relative to bonds. It was interesting to see the pickup in private equity deals in 2019, as private equity sponsors took advantage of low equity valuations in certain sectors combined with low financing rates to take listed companies private. If investors are not prepared to close these valuation gaps, then perhaps private equity sponsors will?

A positive outlook for income in the UK equity market

The start and the end of the decade saw dividend cuts from several high-profile companies. The UK remains a diverse market for income, dampening the effect that any individual sector may have on total distributions. It is worth reminding ourselves that dividends only fell 13% from peak to trough in the global financial crisis. History shows that as certain sectors have come under pressure others have taken the strain.  Part of the skill of an income fund manager is to invest in those companies that can grow their dividends and avoid those that cut them. Some investors shun income investing, preferring to look for companies with higher growth. The two are not mutually exclusive. As active investors, we are not forced to own all the constituents in the index, and we can invest in companies that are able to grow their dividends at a rapid pace. The AXA Framlington UK Equity Income Fund has just 37 holdings, of which seven that have grown their dividends at over 10% per annum for the past five years. We believe the outlook remains positive for income growth. 
 

Bull Points:         
The UK stock market stands at a big discount to its international peers.
The dividend yield on the FTSE All-Share Index remains attractive and is likely to grow.

Bear Points:       
Valuations aren’t bargain basement.
Some companies will cut dividends in 2020.

 

 

[1] FTSE Russell – FTSE All-Share Indexes, 31 December 2019 https://research.ftserussell.com/Analytics/FactSheets/temp/a412b5b9-aa82-4bed-951f-60612b04806f.pdf

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