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The changing face of equity income investing in the UK

We look at how the UK equity income sector is changing and how our UK equity income Wealth Shortlist funds compare to the wider sector.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Banks, utilities, healthcare and oil & gas have long been mainstays in UK income investing. Although the pandemic meant we saw some big dividend cuts, these sectors have generally provided reliable and growing dividends for a number of years.

However, while these sectors, together with larger companies and the UK more generally, are still popular with investors, other less traditional areas are now finding favour with some UK equity income investors.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments can fall as well as rise in value, so you could get back less than you invest. Income is variable and not guaranteed.

How are traditional areas for income changing?

Banks

Within the Investment Association UK Equity Income peer group, the weighting to financial companies has bumped up over the past ten years. However, within this broad sector, investors are looking increasingly beyond banks. Instead they’re turning more of their attention to insurers, brokers, investment platforms and asset managers.

Banks’ fortunes are often linked to the health of the economy and they’ve had a tough time since the global financial crisis. However, they’re now on a firmer footing and many still believe they have an important role to play in providing diversification within a portfolio.

Within our Wealth Shortlist, UK equity income funds Marlborough Multi Cap Income, Jupiter Income, Aviva UK Listed Equity Income and Artemis Income all have more in financial companies than their peers.

Jupiter Income looks for opportunities in unfavoured areas of the market and has an eye for a ‘bargain’. They think banks are cheap because investors are expecting slow growth in the economy. They hold the Asian focused Standard Chartered which they see as undervalued by the market, but also potentially higher growth given the strength of its balance sheet and reputation in the region.

Aviva UK Listed Equity Income has tended to hold insurance companies and asset managers as opposed to banks. They think insurers like Phoenix Group have stronger business models that rely less on a strong economy, which could result in better long-term returns. To add to that, they think changes to pension regulations could drive the long-term prospects for wealth/asset managers, like Schroders in the UK.

Artemis Income finds good opportunities across the sector. It holds the financially strong Barclays which is well placed in the US market and has what they consider to be an undervalued card payments business. They also like the restructuring story at insurer Aviva which has sold a lot of non-core businesses. But also London Stock Exchange, which is increasingly moving into digital financial data.

Healthcare

Weightings to healthcare stocks have declined over recent years. Half of the funds in the equity income sector of the Wealth Shortlist have less in healthcare than their peers.

Threadneedle UK Equity Income slightly bucks this trend and has larger holdings in both AstraZeneca and GlaxoSmithKline.

They’re currently excited about the prospects surrounding GlaxoSmithKline as it sells non-core parts of the business to return cash to shareholders. Some of their drug pipelines also have the potential to be key players in the areas of vaccines, anaemia and hepatitis.

AstraZeneca has emerged as one of fastest growing global pharmaceutical companies with treatments in some fast-growing areas of biopharma.

Oil & Gas

Oil & Gas was an area which once dominated UK equity income investing, but its influence has waned over the past ten years. Three of our Wealth Shortlist funds – Troy Trojan Income, Aviva UK Listed Equity Income and Threadneedle UK Equity Income – have no (or virtually no) holdings at all.

There are obvious doubts as to how long demand for fossil fuels will last and the environmental impact of their use and extraction. Of our Wealth Shortlist funds, it’s perhaps not surprising to see that the recovery focused Jupiter Income has a good-sized holding in BP. They expect BP to successfully transition away from fossil fuels to renewable sources of energy over the coming decades.

Utilities

Utilities is another area that’s become less popular with UK equity income investors over recent years. Of the Wealth Shortlist funds, Marlborough Multi Cap Income and Aviva UK Listed Equity Income both have more invested here.

Marlborough see utilities as a defensive part of the portfolio – something that isn’t as dependent on the strength of the economy. They think utilities can offer real dividend growth, which is helpful when there are fears about inflation.

These companies are often moving to more environmentally friendly forms of operating, like Drax who are making the switch away from fossil fuels to renewable sources of energy. Aviva highlight SSE, who are increasingly using offshore wind as a source for electricity generation.

What about the alternatives?

Basic materials sector

Basic materials sector earnings and cashflows can be dependent on how well the global economy is doing, meaning it can be a risky place to invest. But over the past ten years, the weighting to the basic materials has increased within the UK equity income peer group.

Artemis Income holds Anglo American, which is benefiting from the current recovery in commodity prices. It’s also a major copper producer, which is needed for the move toward electrification. Aviva UK Listed Equity Income invests in BHP which gives investors exposure to Chinese demand for iron ore. It also offers an attractive income relative to others in the sector.

Other countries

UK equity income managers mainly invest in UK companies, but they can invest up to 20% overseas. The concentration of dividends in the UK has increased dramatically over recent years. So having the flexibility to look at higher-yielding companies in different industries and countries can help spread risk.

On the Wealth Shortlist, both Troy Trojan Income and Jupiter Income have the most weightings in overseas companies.

Troy Trojan Income looks for dependable and reliable dividends and they’re willing to pay a little more for this quality – they currently have holdings in Experian, Paychex and Nestle.

Jupiter Income on the other hand looks for good companies that are a bit unloved but can be picked up for a song. They have holdings in the more cyclical Airbus, VW and Nokia.

Smaller companies

Historically UK equity income investing has been focused around larger companies. Large companies have often paid dividends for generations and are in a better position that others to weather any economic storms.

However mid-sized and smaller companies that might not be as well-known can be a good place to find income. Fund managers are increasingly finding more opportunities in this part of the market.

Smaller companies are often able to grow their earnings faster than large companies, which can mean their dividends grow quicker, but they might not be as reliable. They can also offer diversification from larger companies, but are higher risk.

Within the FTSE 100, just 15 companies are responsible for around two thirds of all dividends paid out in the UK. Funds that invest in large, mid and smaller sized companies could have a role to play in a diversified portfolio.

On the Wealth Shortlist Marlborough Multi Cap Income, Threadneedle UK Equity Income and Aviva UK Listed Equity Income all have more invested in small companies than the wider market. While they could offer potentially higher returns, these returns do come with more risk.

What should investors take from this?

There’s no right answer when it comes to deciding how much to invest in each sector within a UK equity income fund. As you can see, our Wealth Shortlist managers all have different views and reasons for or against different areas of the market. We expect that and think it’s healthy.

While you can favour an approach or style because it has more invested in an area you like, it’s important that investors hold funds with a number of different investment styles. That way you could always have something doing well.

Investing in funds isn’t right for everyone. Investors should only invest if the investment’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. These funds take their charges from capital which can increase the yield on offer, but reduce the potential for capital growth.

FIND OUT MORE ABOUT ARTEMIS INCOME, INCLUDING CHARGES

ARTEMIS INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT AVIVA INVESTORS UK LISTED EQUITY INCOME, INCLUDING CHARGES

AVIVA INVESTORS UK LISTED EQUITY INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT JUPITER INCOME, INCLUDING CHARGES

JUPITER INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT MARLBOROUGH MULTI CAP INCOME, INCLUDING CHARGES

MARLBOROUGH MULTI CAP INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT THREADNEEDLE UK EQUITY INCOME, INCLUDING CHARGES

THREADNEEDLE UK EQUITY INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT TROY TROJAN INCOME, INCLUDING CHARGES

TROY TROJAN INCOME KEY INVESTOR INFORMATION

Please note Troy Trojan Income holds shares in Hargreaves Lansdown PLC.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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