Key takeaways
Over the past 12 months investors have been forced to acclimatise to an uncomfortable inflationary environment. Global policymakers responded in unity, unleashing a rapid tightening cycle in an attempt to prevent heated markets from boiling over.
Investors continue to monitor macroeconomic data points to determine the efficacy of such attempts. However, we can at least make some initial observations from what some may perceive to be our new ‘base case’ for interest rates.
Income investors will likely be aware of the narrowing equity yield premium over fixed income asset classes, which is now at its lowest in over a decade. Equity income investors seeking to safeguard this premium, in potentially volatile markets, may consider the FTSE 100 as a natural hunting ground for a resilient and growing income stream.
Below, we present three reasons why UK and European dividend investors should consider the UK market as a core component of any income strategy:
1. The UK offers an attractive yield premium to other regions
For some time, the UK has generated an attractive dividend yield relative to alternative regional markets. As at today, the UK market yields more than nearly all other developed markets and over double the income generated in the US (figure 1).
Even with interest rates rising rapidly over the last year, equity investors still enjoy a healthy yield. In addition, we could then factor in the impact of capital returns, share buybacks, and the erosion of fixed income purchasing power in an inflationary environment.
The propensity of businesses to grow their dividends therefore becomes an important consideration for income investors.
Source: Siblis Research, based on regional MSCI indices, as at 31/12/2022
2. Why the composition of the UK market is attractive to dividend investors
We do not need to reflect for long to assess how certain markets responded to an extreme period of volatility. Across the globe, dividend cuts were inevitable throughout 2020 and enabled many businesses to emerge from the pandemic in a stronger competitive position.
And, a significant proportion of the UK market can be found in dividend paying sectors too, such as, consumer staples and commodities. In fact, each of the UK sectors generating a positive relative total shareholder return (TSR) in 2022 are healthy dividend sectors, reinforcing the importance of income as a component of total return (table 1)
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Source: HSBC, as at 31/12/2022
*FTSE 100.
3. The dominance of income in UK returns is unique
For the reasons above, we believe income will continue to be a material component of total return within the UK market. And, this will mainly be driven by the sector exposure of the FTSE 100, which accounts for 80% of the FTSE All Share.
Over the last 15 years, the FTSE 100 has generated returns of around 5.2% per annum, but around 4% of this annualised performance was generated from constituent dividend income (figure 2).
This highlights the prominence of income as a component of total return in the UK. This structural preference for income within the index is unique across the globe and offers a compelling opportunity for investors
Source: Bloomberg, as at 31/12/2022
Past performance is not a reliable indicator of future returns.
A hunting ground for active management
To us, this highlights the importance of active management. By allocating passively to the UK market, investors will enjoy a healthy dividend yield, but our active approach enables us to target a yield of 110% of the UK market.
When income is such an important component of total return, a 10% minimum (often higher) premium begins to compound at a rapid rate – figure 3 demonstrates the cumulative total return of our UK equity income strategy vs the FTSE All Share. On an annualised basis, this has amounted to over 200 basis points of additional annual return over the last ten years.
Source: Morningstar, as at 31/12/2022.
Past performance is not a reliable indicator of future returns.
We typically maintain a minimum of 70% exposure to FTSE 100 businesses. However, our active approach also enables us to select companies in the FTSE 250. Here, we are able to seek out dividend payers that are less mature in nature and have a runway ahead for rapid capital and income growth. This flexibility reflects our focus on delivering an attractive total return from this strategy.