Income funds have long been popular with British investors. More than £28bn is currently invested in the sector. But savvy income seekers are now looking abroad. Should you join them?
A couple of years ago the big banks dominated many UK income funds. But the financial crisis triggered huge dividend cuts. So now there are only a few key players left in the big payout league. Indeed, beleaguered BP, Shell, GlaxoSmithKline, Vodafone and HSBC account for about half of UK dividends.
“The UK market is very top-heavy, with a small number of companies providing the bulk of the dividend from the stockmarket as a whole, and the risk in this is neatly highlighted by the plight of BP,” says Tim Cockerill, head of research with Ashcourt Rowan Asset Management in the Financial Times. News that BP, led by CEO Tony Hayward, might suspend its dividend next month due to its continuing woes in the Gulf of Mexico is causing fresh problems for income fund managers. BP is the largest holding in 40 out of 86 UK income funds and a further 23 funds also hold the oil firm. So a cut, or even a suspension, of its dividend could have a big impact on returns.
The UK income sector’s overreliance on relatively few firms is leading some investors to turn their attentions abroad. Aberdeen Asset Management has announced it will be launching a Latin American Income fund, which will aim to yield 4.25% by investing in income stocks and sovereign (government) bonds. And JP Morgan is creating the JP Morgan Global Emerging Markets Income Trust.The advantages of seeking income on a wider stage are obvious. With more stocks to choose from there is less chance of an individual dividend cut significantly affecting the fund’s return. And as for worries about emerging market income safety, the BP saga shows that even once rock solid Western brands can falter.
One of the better funds in this space is M&G’s Global Dividend fund, says Heather Connon in The Observer. It’s outperformed the FTSE 100 with a return of 28.5% over the past year. But while the sector is currently out of favour, Neil Woodford’s Invesco Perpetual UK Income fund looks good too. Woodford (one of the “top stock pickers of his generation”, says the Evening Standard’s Simon English) cleverly sold BP last October. He also notched a 0.6% gain for May, says Lipper, as most funds were losing money.