Is the UK still one of the best markets for income investors?

The UK has long been a go-to destination for income investors. A combination of cash-generative businesses, a strong dividend culture and a bias towards mature sectors have historically made it one of the highest-yielding stock markets in the world.

Now, that’s still largely true, but the narrative has evolved.

This article isn’t personal advice. All investments can rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future. If you're not sure what’s right for you, then ask for financial advice.

Why the UK stands out for income

The UK market is built differently from many global peers.

Although the US is dominated by fast-growing technology companies that reinvest earnings, the UK has greater exposure to sectors like banks, oil & gas, pharmaceuticals, utilities and consumer staples. These are typically more mature industries with steadier cash flows and more likely to return profits to shareholders as dividends.

That’s helped keep UK dividend yields higher. At the end of May, the UK’s FTSE All-Share index yields 3.12%, comfortably ahead of the broader global stock market.

For investors, that’s a solid starting point.

Why yields have fallen

Although the UK is still one of the highest-yielding markets, yields aren’t quite as elevated as they have been.

But this isn’t because of a collapse in dividend payments. Instead, share prices have risen in some of the UK market’s traditional income-generating sectors. As prices rise, yields naturally fall, even if companies are paying the same, or more, in dividends.

There’s also been a shift in how companies approach payouts.

Following the COVID-19 pandemic, many UK firms reset their dividends to more sustainable levels. That has left payout ratios (the proportion of earnings paid out as dividends) lower than before and suggests that UK dividends are better supported and potentially more resilient than they were in the past – though as ever, no dividend is guaranteed.

Dividends are only part of the picture

Income investors focusing purely on yield might be missing part of the story.

In recent years, UK companies have increasingly used share buybacks, not just dividends, to return cash to shareholders. This trend has picked up as companies look to take advantage of what they see as undervalued share prices.

Buybacks reduce the number of shares in issue, which can boost earnings per share and, over time, support dividend growth.

The energy giant Shell is an example. It has been rebuilding its dividend after pandemic-era cuts, while simultaneously running a large buyback programme. Together, this has delivered meaningful total returns to investors – even if the total dividend remains lower today.

For investors, it’s a reminder that income isn’t about just the yield you see today but the total cash returned over time.

A valuation opportunity?

Another factor supporting the case for UK income is valuation.

UK shares have traded at a discount to global peers for many years. That discount widened after Brexit and has yet to fully close, even though many UK-listed companies generate a significant proportion of their revenues overseas.

Related article: Brexit 10 years on – the impact on the UK economy and investment

For investors, this creates an interesting combination – relatively high income alongside relatively low valuations. That provides scope for capital growth if sentiment towards the UK improves.

There’s already some evidence of buyers looking to take advantage of the value on offer in the UK, including among international investors. Ongoing takeover activity suggests that overseas investors recognise opportunities that public markets might be overlooking.

Don’t ignore concentration risk

Although the UK offers attractive income, it’s not without risks.

One of the main ones when it comes to income is concentration. A large proportion of UK dividends comes from a relatively small number of companies, with more than half of total payments generated by the top 15 names.

That means that income levels could, in theory, be vulnerable if a small number of big payers cut or suspend their dividends. The pandemic highlighted this clearly, when regulatory pressure and economic uncertainty led to widespread cuts, particularly among banks and insurers.

For investors, diversification is key. Spreading exposure across sectors, while holding UK funds alongside other global funds or asset classes like bonds, can help smooth income over time.

Fund ideas for UK income

Funds can provide broad exposure to the UK market’s income opportunity.

However, investing in these funds is not right for everyone. Investors should invest only 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 that any new investment forms part of a long-term diversified portfolio.

For more details on each fund’s objectives, its charges, and specific risks, see their factsheets and key investor information. As always, yields and income are not guaranteed and will change over time. Both these funds take charges from capital, which can increase income but does reduce the potential for capital growth.