Income investing: “It is not all doom and gloom”

16th December 2015


The trends of commodity prices and market capitalisation will continue to shape trends in the UK equity dividend market writes Richard Marwood, manager of the AXA Distribution fund…

The sustainability of UK dividends will remain a hot topic in 2016, especially in the context of the path of commodity prices in the next 12 to 18 months. If we stay at such low price levels, commodity related companies will continue to face very tough decisions on costs and dividend payouts.

Meanwhile, dividend growth is expected to be negative for FTSE 100 companies in 2016 at -1.04% compared to the FTSE 250, which is expected to grow at 6.7%1. So there is plenty of income growth available in the market, but one needs to be very selective and look at the underlying company fundamentals to evaluate the sustainability of dividends.

The level of sterling will also influence the future of UK dividends. Several large multinational companies such as BAT International, Diageo and Vodafone rely heavily on their overseas earnings. If sterling strengthens relative to overseas currencies, pressure will mount on these companies’ earnings and as a result, on their dividends.

One topic that will have a significant impact on the level of sterling is the possibility of Brexit. This debate, which could last up to four years, will be a source of uncertainty for the currency. This lack of clarity could weigh on sterling, a potential positive for companies with substantial overseas earnings.

2015 was a very brisk year for Mergers & Acquisitions (M&A), with mega deals like Royal Dutch Shell / BG and Inbev / SAB Miller and a whole host of smaller takeovers such as Rexam, Telecity, Colt Telecom, Infinis, AGA and Chime Communications. M&A is likely to continue as a theme as we move into 2016, with companies with attractive brands, technologies or market positions the most likely to tempt overseas acquirers.

Companies with strong business models, good management and high barriers to entry are often well-positioned to provide better long-term dividend streams. However, in today’s slighter tougher environment for equity dividends, investors seeking income in the UK market can look beyond stocks and towards inflation-linked bonds.

Inflation should rise in 2016 on the back of two factors: as a result of the base effects of oil dropping out, and due to the impact of the government-mandated switch from the minimum wage to the new national living wage next year.

Although bond yields are currently low, these inflation-linked bonds are designed to counter the eroding effects of inflation, as their income from coupons and redemption payments are linked to the Retail Price Index (RPI).

Therefore a combination of dividend-paying equities and inflation-linked bonds is a good way to generate income in a portfolio, while interest rates remain low.

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