INVESTORS and pension savers may need to look further afield for income after a benchmark report predicted a slowdown in the dividends paid by UK blue chips.
Income payouts to investors have been hit by a combination of slower global growth, weaker profits and the strong pound, according to the latest UK Dividends Monitor from Capita Asset Services.
It has warned of a fall in the income paid out in real terms, having previously predicted record payouts of more than £100 billion for 2014. It now expects a total 2014 dividend payout of around £97bn, followed by a drop to £85.8bn next year.
Justin Cooper, of Capita Asset Services, said: “We always expected 2014 to be a year of slow growth for dividends, but it’s rapidly turning into a year of no growth.”
The dividends from the FTSE 100 companies, which account for the bulk of the payouts received by investors, fell 1.1 per cent to £22.8bn in the three months to the end of September. Those dividends were affected by the strength of sterling against the dollar, as many of the biggest blue chips pay dividends in the US currency.
Dividends from FTSE 250 companies were more resilient, rising 7.6 per cent, yet those payouts represent less than 10 per cent of the UK total.
With interest rates still low, dividends still represent one of the best sources of income for investors, however. And it’s not just about income, as the compounding effect of dividends also makes them a key driver of investment growth.
Reinvested dividends accounted for more than two thirds of returns on UK stocks over the past 100 years, according to the latest annual Barclays Equity Gilt Study.
A £100 investment in the FTSE All Share Index when it launched in 1986 would now be worth £512, on the basis of capital returns. But if the dividends had been reinvested along the way, the total return would by now have reached £1,476.
David Thomson, chief investment officer at VWM Wealth in Glasgow, said: “Many investors are rediscovering the power of dividends as an important element in the pursuit of long-term total returns.
“They also deliver an even greater proportion of total returns in periods of low growth such as we are currently experiencing.”
Dividends protect against inflation too, he added.
“Dividend-paying companies can, over the long term, provide an inflation hedge – dividend income grows in line with (or often at a higher rate than) inflation.”
The easiest way for ordinary investors to benefit from equity dividends is through collective funds such as unit trusts and investment trusts. The latter have a particular advantage as they are allowed to set aside up to 15 per cent of their income in reserve each year so they can maintain payouts during fallow periods.
Research earlier this year by the Association of Investment Companies showed that 35 investment trusts have increased the dividend paid to investors for each of the past ten years. They include 15 trusts that have done so every year for at least 30 years, including Dundee-based Alliance Trust, the Scottish Investment Trust and the Scottish American and the Scottish Mortgage investment trusts run by Baillie Gifford, the Edinburgh investment house.
Those trusts derive a growing proportion of their income from overseas, while several fund firms now offer emerging markets income vehicles.
Funds focusing primarily on the UK are dependent on a select band of firms for their payouts. More than a third of dividends are supplied by just five stocks – Royal Dutch Shell, BP, Vodafone, HSBC and GlaxoSmithKline (GSK) – according to Capita.
And while UK blue chips still pay out far higher dividends than large firms in other countries including Germany and France, the rate of dividend growth has slowed of late and several of the UK’s biggest dividend payers, including Tesco and GSK, have hit tough times.
“While many of these companies have global operations, such as the major oil companies, we prefer to reduce risk through diversification and access to a wider range of companies and markets,” said Thomson.
Among the funds he uses for exposure to non-UK income (and therefore greater diversification) are the M&G Global Dividend and the Newton Global Higher Income.