Chand Lall’s income fund is currently yielding just over 5 per cent, which he believes he can achieve without increasing volatility, using a highly selective approach.
But as a rule, Murray Income Trust manager Charles Luke believes a 4 per cent dividend yield represents the “sweet spot” for the UK equity income sector. This gives “the ability to invest in companies with an attractive dividend yield without sacrificing quality”, he says.
“Although higher dividend yields are available, the risks that these may end up being cut start to increase rapidly above this level,” Luke warns.
Keeping up with inflation
He is a firm believer that UK equity income funds are attractive in times of higher inflation as they represent real assets whose earnings and dividends, assuming strong pricing power, have the ability to keep up with inflation.
However, he adds: “It’s worth noting that it tends to be those companies with sustainable competitive advantages that are best placed to keep up with inflationary pressures.”
Sue Noffke, manager of Schroder Income Growth, which currently yields 4.3 per cent, highlights a particular advantage of the trust variant in tricky times of high inflation.
“Equity income investment trusts typically have revenue reserves, accumulated from not having paid out to shareholders all dividend income received in each prior period — reserves that may be used to supplement income payments to investors in more challenging periods for equity income or higher inflation,” she says.
The Schroder Income Growth fund supplemented dividends to investors in the pandemic years of 2020 and 2021 by using some of this held back cash. It has retained strong reserves, with 10.5 months of revenue reserves in relation to the last annual dividend it paid.
One question to ask is, will the UK equity income sector give a better return than bonds in the coming months?
City of London Investment Trust portfolio manager Job Curtis admits “bonds are yielding more”, but he adds that “you have the prospect of growth in income from equities”.
Dividends from equities will typically rise over time reflecting growth in profits from companies. Income from bonds is fixed. In inflationary periods, equity income has a chance of keeping pace with rising prices whereas bond income will be eroded in real terms.
In Curtis’s view, there is scope for low single-digit percentage dividend growth from UK equities for the rest of 2023. “Consumer staples companies, banks and the oil majors should contribute to this growth,” he says. In contrast, he is expecting reduced dividends from most mining companies.
