Active U.K. Income Funds Endure Challenging Times

The U.K. has been one of the worst-hit countries in developed markets in terms of dividend cuts in 2020. One in two dividend-paying companies in the S&P United Kingdom BMI have cut dividends, while half of the remaining companies are also expected to cut dividends.1 A tough year indeed for equity income managers, as opportunity to differentiate abates in the near term. This blog explores why this may be so and draws attention to the benefits of indexing under the current environment.

Selection Pool for Dividend Growth Strategies Has Shrunk Significantly

Prior to the pandemic, there were a little over 300 dividend-paying companies within the S&P United Kingdom BMI, but this has now fallen to just under 200. Despite the reduction, this may still appear to be a sizable selection universe for dividend funds. However, the impact could be amplified depending on the type of dividend strategy. For example, a consistent dividend growth strategy would select companies that have maintained stable or growing dividends for a certain number of consecutive years. Exhibit 1 illustrates that the number of such companies has fallen by more than 50% since 2018.2

Dividend Portfolios Could See Convergence in Holdings

At present, approximately GBP 60 billion3 of assets are currently in U.K. dividend-based strategies, mostly in active funds. Many of them may employ dividend growth strategies. The potential implication of a reduced selection pool is an increased likelihood of holdings overlap between these active dividend funds.

While an accurate comparison of holdings between active funds is challenged by inconsistent reporting dates and incomplete disclosures, there were some interesting observations.

Sustainable dividend payers such as GlaxoSmithKline, Phoenix Group, British American Tobacco, Legal & General Group, and RELX were among names found to be commonly present in many of the largest income funds,4 all of which are also present in the S&P UK High Yield Dividend Aristocrats® Index. Intriguingly, the top four active income funds, with combined assets of almost GBP 15 billion, were each also observed to have at least 35%, and an average of 46%, of their respective assets invested in stocks within the S&P UK High Yield Dividend Aristocrats Index,5 a figure that could rise even further.

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