Tap into high dividends for a reliable income

INCOME-SEEKERS have had a torrid time of it over the past 18 months or so. Faced with a market in meltdown and reduced margins, even the most reliable of dividend payers such as BT have slashed their pay-outs to shareholders. But there are signs that the dividend market is picking up once again.

Several UK fund managers have reported a growing interest in overseas equity income funds, according to the latest UK fund report from Lipper, a data provider. Both BNY Mellon’s Newton range and the Schroder Income Maximiser have been beneficiaries of this thirst for income.

At the end of last month, Unilever, Imperial Tobacco and GlaxoSmithKline all announced that they would increase dividends, while oil giants BP and Royal Dutch Shell said they would keep shareholder pay-outs unchanged. And while Capita Registrars’ latest Dividend Monitor showed that pay-outs to institutions and fund managers were down 2.5 per cent in the first quarter on the same period of 2009, this was the slowest pace of decline since the recession began.

ING Investment Management has predicted strong – and possibly double-digit – growth in dividends over the next couple of years, driven by stronger corporate cash flows and balance sheets.

There are three reasons why it believes that dividends will see strong growth and thus translate into better performance for high dividend strategies.

First, dividend increases will be facilitated by the fact that the pay-out ratio – the percentage of earnings paid to shareholders in dividends – is, given where we are in the economic cycle, at considerably lower levels than in previous recessions. In a maturing market with earnings growth and a contraction in stocks’ price-to-earnings (p/e) ratio, there is room for companies to grow their dividends.

Secondly, “dividends are very important for investors and even more so in this low interest rate environment,” says Nicholas Simar, head of value at ING Investment Management, pointing out that around 80 per cent of total shareholder returns comes from dividends. Now that payouts are close to the level of corporate bond yields, there’s even more reason for institutional investors to start looking more closely at this form of income again.

And finally, by buying equities rather than bonds, investors will have an attractive dividend yield, which is the only constant positive source of return as both capital gains and dividend growth (independent of yield) can turn negative.

They will also benefit from the option of future dividend growth, providing them with a regular and less volatile source of income even in choppy markets.

However, the UK and Eurozone offer the least attractive high dividend investment opportunities. British institutional investors should therefore be prepared to look overseas to Japan and the US, ING IM warns. Its Global High Dividend fund is overweight Japan by 8.74 per cent and the US by 8.42 per cent relative to the MSCI World High Dividend Yield Index.

The cumulative performance of the fund lags the benchmark very slightly – 15.38 per cent for the fund compared to 16.06 per cent. It has an annual management fee of 1.5 per cent.

In a world characterised by low interest rates and difficult markets, institutional investors such as pension funds will benefit from the regular income that high dividend funds can provide.