Global equity income – is it time to look again?

Income funds come in all shapes and sizes. Whether you’re looking for a steadier stream of income or one that has the potential to grow over time, there are lots of options.

As an investment style, income’s sometimes seen as a bit dull and boring. It’s typically associated with industries that have lower growth potential, but more predictable earning streams like utilities, telecoms and essential consumer facing companies.

How has global income been coping?

The past five years have been tough for global income investors. Over this period, the average fund in the IA Global Equity Income sector hasn’t performed as well as the broader global stock market*. They’ve also underperformed the IA Global sector, where funds have tended to focus on growth over income.

Percentage Growth, TR Def, ExD, Def, GBP 30/11/2016 to 30/11/2021

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Source: *Lipper IM, to 30/11/2021.

Past performance isn’t a guide to future returns.

On the surface this might look disappointing, but it’s hard not to sympathise with income managers.

To qualify for the IA sector, funds must achieve a higher yield than the broader global stock market. Naturally, this leads many to the higher income generating sectors, which are often associated with more mature, value-orientated companies. This makes it harder to invest in higher-growth industries, like technology, where many companies use their excess cash to reinvest back into the business to fuel future growth, rather than pay a dividend.

A technology headwind

For income managers, the performance of technology companies, who have largely benefitted from life in lockdown, has been a headwind for performance. The way we work, consume and interact has rapidly changed and those with the ability to tap into these trends have reaped the rewards.

The US is home to some of the world’s most innovative technology companies which have collectively propelled the region’s performance well ahead of global peers over this period. Plenty of funds in the IA Global sector, who aren’t restricted by yield, have benefitted from this trend.

More broadly, the US makes up almost 60% of the FTSE All-World Index. But despite the treasure trove of opportunities on offer, it doesn’t pay as much in the way of dividends.

In fact, 30% of the US market doesn’t pay a dividend and over half of its companies don’t pay one in excess of 1%. For example, the notably successful ‘FAAMGs’ – Facebook (Meta Platforms Inc), Amazon, Apple, Microsoft and Google (Alphabet Inc) fall into this bucket.

That’s not to say income managers won’t invest here and there are exceptions to the rule. But, by investing in lower yielding companies, they are often faced with a trade-off between the potential for higher income or higher capital growth. Remember, higher-yielding companies tend be slightly riskier.

Income beyond our shores

Domestic investors have tended to stay closer to home on their hunt for income, but the UK has weighed on returns. UK companies have historically benefitted from a strong dividend culture and generated an attractive yield compared to other developed markets. Although they’re listed on the London Stock Exchange, lots of these companies generate sales beyond our shores. That means investors tap into international revenue streams without being as at risk of big swings in the exchange rate – also known as currency risk.

Covid-19 put downwards pressure on dividends worldwide, but UK companies were among some of the worst affected in 2020. Sectors like oil, mining and banks felt the most pain, with HSBC’s dividend cancellation being one of the largest individual cuts in the world.

While UK income investors will be all too familiar with the pain of last year, dividends in regions like Europe, Asia and emerging markets were largely resilient to the impact of the pandemic. Although set at a lower level than many global peers, North American dividends were also fairly unscathed.

That’s why looking more globally for income could be a good way to diversify your portfolio.

Global income managers are fishing in slightly different waters to other global funds seeking capital growth. This means you get to tap into different regions, industries, and investment styles.

To put this into perspective, here’s a look at the sector differences between the FTSE All-World and FTSE All-World High Dividend Yield Index, which represents companies with a higher than average yield. Remember yields are not a reliable indicator of future income. All income is variable and not guaranteed.

Sector weighting (%)

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Source: FTSE Russell, October 2021.

Sectors like banks, energy and food, beverages, and tobacco account for a large weighting in the FTSE All-World High Dividend Yield Index, and a much lower weighting in the FTSE All-World Index. In contrast, the weighting to technology is much bigger in the FTSE All-World Index – this helps explain the difference in how they both did.

The geographical makeup of a global income fund can look quite different too. Unsurprisingly, lots of income managers invest a lot less in the US which could complement other global funds.

It’s important to remember that funds in this sector aren’t restricted to only those in need of income. Investors looking for capital growth can always reinvest their income using an accumulation (Acc) share class.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. Investments and any income they produce can rise as well as fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Is income back on the menu?

We’ve discussed some of the reasons why global income funds at a sector level haven’t reached top gear just yet. But what does the outlook look like going forward?

Dividends have come a long way since the darkest days of March 2020 thanks to the support from government and central banks. This alongside the global rollout of a Covid-19 vaccine has provided lots of companies with the confidence and ability to turn the income tap back on.

The third quarter of 2021 was a record-breaking one for dividends. Over this three month period, 90% of companies around the world either increased or maintained their dividend. Sectors like mining and banks saw some of the biggest contributors.

If you’re interested in global equity income funds, our Wealth Shortlist could be a good place to start. You can also read more about the global sector in our most recent Global stock market and funds sector review.

Investing in these funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

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