Just as UK income investors were told all is fine for the stability of dividends, fund manager Robin Geffen described risk in this sector as “astonishingly high”.
The founder and chief executive of Neptune Investment Management - and he also manages Neptune’s Income Fund - was referring to dividend risk among companies in the Investment Association (IA) UK Equity Income Sector.
“Too many income managers are loading up on the same handful of stocks to produce their funds’ yields, with just 20 stocks accounting for 57% of the sector’s total dividends,” he said.
At the same time, dividend cover – a measure of pay-out stability – is “extremely low” in the IA sector, with the top 20 largest income-generating stocks having a dividend cover, on average, of just 1.04x.
He said related issues were that the UK economy lagged the rest of the world with productivity growth seeing a sharp decline over the past 20 years, and that the number of bankruptcies – limited by Bank of England stimulus measures – was now increasing materially.
“Investors cannot afford to be complacent in this environment and need to beware zombie companies,” Geffen said, adding that investors of income funds should analyse their underlying holdings.
The Share Centre recently said that dividend cover in the FTSE 350 had become more secure by reaching 1.8x - its highest level for three years.
Geffen said many of the 20 stocks in the IA sector offered the illusion of a high relative yield, but had “twin dangers” of minimal dividend cover and slowing earnings.
“This has meant that, though certain funds have generated considerable levels of income and have consistently offered a high yield, they have done so by sacrificing capital. Some 32% of the sector have lost money in capital terms over the past three years,” Geffen said.
Geffen’s fund was avoiding “ zombie companies”, described as those dependent on a buoyant UK economy and those that have challenged dividends, he said.
In the fund, 15% of the portfolio’s underlying revenue comes from the UK, meaning the fund had the highest weighted average dividend cover across its top 10 holdings in the sector at 2.8x.
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