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Don’t overlook UK income opportunities

Written by: Darius McDermott
2018 was not a good year for UK companies. The stock market suffered its worst year in a decade, falling 12.62% over the calendar year.

As the managers of Artemis Income recently commented: “That 2018 is over is probably the best that can be said about it. After having spent much of the year watching Wall Street’s exuberance from the sidelines, UK investors were engulfed in the aftermath of its collapse, as share prices here followed the US market lower.”

However, while the collective worth of British companies fell, their earnings held up better. This is good news for investors as it means the dividends these companies pay are on more solid ground.

And UK dividends are actually thriving: the dividend yield of the UK stock market stands at an average of 4.8%, with a number of our largest companies paying well in excess of this.

Importantly, nine out of 10 sectors saw dividends rise in 2018, so there is plenty of choice for investors. Even the banking sector – which was hit hard after the financial crisis – is in better shape: the Royal Bank of Scotland recently paid its first dividend in 10 years and Standard Chartered paid its first dividend since 2015. Lloyds is actually distributing more than it did before 2008.

Moreover, the dividend cover (a measure of a company’s ability to pay dividends in the future) of the UK stock market also looks healthy for large, medium and small businesses.

The strength of UK dividends is important not only for investors seeking an income, but also for those looking for healthy total returns. For example, while the UK stock market fell more than 12% last year, if dividends paid by UK companies had been reinvested, the fall was a slightly more palatable 8.82%.

Over the long term, the importance of dividend and compounded returns is even more apparent. For example, if you had invested in the UK stock market 20 years ago on 31 December 1999 and not reinvested any dividends, your pot of money would have only grown by 2%. Yes, only 2%. If you had reinvested your dividends, however, your total return would have been 103%.

So, while the UK stock market is unloved by many investors, we think the current yield makes it attractive. In the short-term, it should help compensate for the risks surrounding Brexit and a slowing global economy and. Meanwhile, over the long-term, the compounded returns should reward investors.

UK equity income funds are the obvious choice for investors looking to make the most of UK dividends. Here are three of my favourites.

Lowland Investment Trust

The managers of this trust are first and foremost stock pickers, but they try to take into account economic factors and this may sway them towards particular companies at different stages of the economic cycle. As contrarian investors, they look for undervalued, out-of-favour stocks and they are prepared to invest early and bide their time. The current yield is 3.96%.

Man GLG UK Income

Investing predominantly in UK companies of all sizes, this fund also has the ability to invest in continental European companies which derive a substantial part of their revenues from the UK. The manager can also invest up to 20% in corporate bonds if he thinks the risk/reward opportunity is better – a flexibility that sets it apart from the majority of its peers. The current yield stands at 4.29%.

Royal London UK Equity Income

This fund has the flexibility to invest in companies of all sizes. The manager looks for those that are unloved by other investors, which he believes have a sustainable and growing dividend. He invests with conviction, which we like, and only increases the number of holdings if he is finding more ideas among smaller companies (to decrease the added risk). This fund currently yields 4.67%.

Darius McDermott is managing director of FundCalibre

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