WHERE is an investor to go to for income these days? Deposit based, property, income funds?
Negative interest rates look like a target for central banks and with cash already producing little more than a mattress, building societies have nothing to offer.
Commercial property is really having a hard time, and what will the near and midterm bring in terms of the need for work access for those returning to work. Covid has demonstrated to many, that working from home is possible, and as such, demand for commercial property will be stunted to some level at least.
Such pressure on commercial property will have a downward impact on their share values leaving them less attractive, and obviously having a downward pressure on rental yields – supply/demand.
In the past, it was easy to love the attractive income funds, which easily pushed out double digit income yields. Meanwhile the capital value also rose, given the attractiveness and demand for the stock.
I remember in early 2016, four companies had double-digit yields and there were many more at 6-8 per cent such as Royal Dutch Shell, Rio Tinto, Aberdeen Asset Management.
Those days may come back but they are not here now. Very much so.
You need to understand the impact of chasing a high yield in your investments.
With fixed interests, the higher the coupon (income), the higher the potential default to capital in the future.
With equities, chasing yield forces the portfolio manager to buy a certain type of stock and style. They tend to be ‘value stocks’ and whilst they are solid, they are very out of favour at the moment.
You are therefore handcuffed to a style where the best capital returns are elsewhere, but because you have targeted a high income, you cannot invest in them as they yield little (i.e. growth stocks – Google et al).
And so, a portfolio full of Woodford’s normal style value stocks will continue to under-perform as they have for the last four years.
Such funds aim to produce a yield (income) on a rolling basis compared to an index and failure to produce such a return will have them removed from an index.
This pressure becomes a crowded trade, given for example, that the top 15 companies in the UK represented nearly 60 per cent of all UK dividends in 2017.
That becomes a positive feedback loop, which easily became the current negative feedback loop – selling, leads to more selling, lowering prices which leads to more selling.
Many shares no longer have a good protection in terms of their cover.
Dividend cover basically calculates how sustainable a dividend is. A cover of 1x or lower suggest the company is using most, if not all of its profits to fund the dividend. A cover of 2x and above is more comfortable in that only half of profits are being used to fund the dividend.
Nine of the top 20 dividend producing stocks today in the FTSE100 have a cover of 2x or less.
Chasing yields can also become a fool’s gold and can easily be marketed otherwise.
Sold in an article at the end of 2017 as ‘too good to pass up’, Capita’s 6.7 per cent yield looked attractive. This was on top of a significant drop in the share price of 63 per cent. When a share price drops and its yield is still the same, the percentage looks much greater and can suck investors in – black hole syndrome.
The reason for the fall may not be reflected in earnings yet and when that follows through, dividends can drop.
Such a black hole was evident in Capita. From that 63 per cent drop, investors searching for income and a bargain of capital growth, would have been battered with a further 93.7 per cent fall in share price.
Remember today that sterling’s fall has greatly exaggerated the dividend yield, as much of the dividend arrives via foreign currencies and when translated into sterling, is uplifted.
In 2017, some £2.1 billion of the increase was accounted for by sterling’s weakness.
:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. For advice on how to take an income from investments, call Darren McKeever on 028 6863 2692, email info@wwfp.net or visit www.wwfp.net.
