Jamie Clark

Eight charts showing the UK yield opportunity

Jamie Clark

In my last two blogs I’ve explained our increased FTSE 100 allocation in terms of both liquidity and valuation. In this final blog on the subject, I develop the argument in discussing the dividend merits of UK large-caps.


Dividend yield is an important, but often neglected marker of value. In discussions of the relationship between value and growth investment styles, it’s typically ignored in favour of other value factors like price-to-earnings, or price-to-cash flow.


This may be because dividend yield is a hybrid metric, expressing both return and value, with investors preferring the clarity of something more absolute. It could follow the fact that dividends are discretionary and arguably less concrete than factors derived from accounting measures.


As income investors with an interest in value companies, the data tell us that dividend yield can be a less reliable predictor of subsequent performance than other value metrics. Looking at average monthly returns by discrete decades, we find that cheap, or high dividend yield companies, has outperformed expensive, or low dividend yield companies, less frequently than other value factors might suggest.


But this isn’t the full story. In common with other value factors, companies that look cheap in respect of dividend yield have on average outperformed those that screen as expensive. This effect is apparent in both the long-run US numbers, as well as more recent UK data. It seems that buying dividend yield does work in the long sweep.


Dividend Yield

But here’s the odd thing: if history shows that buying dividend yield works, why do UK equity income funds feel as unloved as the Game of Thrones finale? According to Morningstar, the UK Equity Income sector saw £15.3bn of redemptions between January 2016 and 2019, reducing sector assets from £75bn to £64bn. It suggests this is the product of Brexit, bad performance and the sector’s broad value tilt [1].


UK Equity Income 

This is moot. What’s more certain, is that this looks stranger still when we consider the puny returns offered by the alternatives. After a decade of low rates, both cash deposit rates and gilt yields are as flat as proverbial pancakes. Factor in CPI inflation at 2% and anyone exposed to these asset classes is suffering real losses. This says nothing of the tragicomic spectacle of the world’s US$14.1trillion of negative yielding debt.


Gilt Yields 

Which poses an apparent conundrum: if buying dividend yield works, but is presently unpopular and yet the alternatives are as alluring as a hippo wearing lipstick, what should we do? As UK equity income managers, you won’t be surprised to learn that we recommend buying UK dividend payers. But this isn’t a blatant case of home bias, the data tell us that now is an unprecedented moment to do so.


The below illustrates that the FSTE 100 offers an attractive dividend yield relative to comparable equity markets. At 4.8%, UK large-caps yield two percentage points more than the average. This is one key reason why we recently cut the portfolio’s overseas exposure and are now fully invested in the UK.


Index Dividend Yields 

That the FTSE 100 offers a yield premium to comparators is unremarkable in itself. Per the below, this has been the status quo in recent years. The effect issues from the FTSE’s relative overweight in high-yielding sectors like oil producers and banks. Brexit too has contributed.


We get a stronger impression of the FTSE yield opportunity by pinpointing the current yield premium in the context of history. Using fifteen years of month-end dividend yield data for the FTSE and its comparators, we calculated the difference in yield and then ranked these differences according to size. We found that the FTSE’s current yield premium was in the 14th percentile of all observations vs the DAX, the 7th vs the Nasdaq Composite, the 5th vs CAC and the 2nd vs the S&P 500. This is extreme and recommends buying the FTSE on a relative yield basis.


 FTSE 100 yield premium

The FTSE’s dividend yield also appeals in terms of its own history. At 4.8%, it comfortably exceeds the 5, 10 and 15 year averages.


FTSE 100 dividend yield 

Confirmation of the opportunity is given by the number of FTSE companies yielding over 5%. The current reading of 38 is unprecedented in the post-crisis era and is more than twice the average in this period. Even if we exclude companies with uncovered dividends and those that feature only by virtue of special dividends, the list still exceeds 30.


FTSE 100 companies 

By this yardstick, the FTSE is also excellent value relative to the FTSE 250 and Small-Cap indices. If we compare the percentage of each index yielding over 5%, it’s clear that there are proportionately more dividend opportunities amongst UK large-caps. 


Index Members 

We have exploited this opening by increasing the portfolio’s FTSE weighting to over 80% of the Liontrust Macro Equity Income Fund. Our top ten holdings include UK large-caps like Rio Tinto, which has disbursed a third of its market cap in dividends since 2014; Legal & General, which has grown its ordinary dividend at a compound rate of more than 14% since 2011; and Royal Dutch Shell, which last year distributed more than £3bn in dividends per quarter.


It is precisely this strategic call which means we can offer investors an eye-catching 5%-plus dividend yield that’s grown at a compound rate of 6.4% since the Fund’s inception in 2003.

[1] Morningstar, UK Equity Income Funds Struggling to Retain Assets: Poor performance is driving investors away, June 2019.

For a comprehensive list of common financial words and terms, see our glossary at: https://www.liontrust.co.uk/glossary


Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, August 7, 2019, 4:31 PM