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Looking to the horizon

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8 May 2019

David Prosser explains why he thinks advisers and investors should not restrict themselves to just UK Equity Income funds.

Memo to financial advisers looking for income-generating investments for their clients: UK dividend payments rose 16 per cent during the first quarter of 2019 and are on target to exceed £100bn for the first time ever over the year as a whole. Second memo to such advisers: pay-outs in other international markets are rising even more quickly.

Amid the economic and political turmoil of these tumultuous times – and the headlines about record low interest rates – it’s easy to lose sight of the fact that income seeking-equity investors have never had it so good. Dividend payments have been on an upwards trajectory ever since the financial crisis of a decade ago.

The question for advisers is how best to give clients exposure to that story. The popularity of UK Equity Income investment companies in recent years is understandable, given that funds in this sector offer a direct play on the UK stock market’s run of bumper dividend pay-outs. But might it now be time to look further afield too?

One argument for doing so is that there may be more value to be found in international funds. Investors’ liking for UK Equity Income funds has seen shares in many funds in the sector trade at ever smaller discounts to the value of the underlying assets and, in some cases, premiums. Overseas trusts are often available on less demanding ratings.

More fundamentally, adding international exposure to the portfolio provides valuable diversification benefits. In a volatile marketplace, those benefits look especially attractive right now.

Moreover, the dividend track records of many international markets are even more impressive than that of the UK. Pay-outs by North American companies are up 153 per cent over the past nine years. In Japan, the equivalent figure is 158 per cent. And across the rest of the Asian region, payments have grown by 164 per cent over the same period.

In other words, advisers and investors who restrict themselves to UK Equity Income funds risk missing out both on superior returns and an opportunity to mitigate their risk exposures. There are some excellent UK funds available, but it would be a shame to overlook international equivalents.

Of course, an investment company isn’t the only collective fund structure through which it is possible to access income-generating investments. And for those considering open-ended funds, the debate about value doesn’t apply, since the structure of these vehicles means they do not trade at discounts or premiums.

Still, investment companies do offer crucial advantages when it comes to income. Most importantly, unlike open-ended funds, they’re entitled to maintain pots of dividend reserves, building up a buffer of cash in good years for dividend receipts in order to fund payments to investors in leaner times. This enables investment companies to pay more predictable and stable levels of income.

With shareholders’ permission, investment companies can also dip into capital to pay income if they deem it necessary to do so. For investors pursuing income more single-mindedly, this flexibility can be very valuable.

The trick is to spread your bets. UK Equity Income looks set to continue to be popular, with forecasts of further increases in UK dividends to come this year. But overseas income funds look highly attractive too.

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