In the second quarter of 2020 dividends paid by UK companies fell by 57%. Just a quarter of dividend-paying constituents of the FTSE 350 maintained or increased payments. For the year as a whole, dividends paid by FTSE 100 firms are forecast to be 32% lower than last year.
As a result, the UK equity income section of the funds market has become something of a graveyard, with many five-year performances negative. The sector’s fall from grace has been exacerbated by the exaggerated expectations of the past, based on a combination of the hunt for income in a world of falling bond yields and interest rates, and a misunderstanding of the pattern of historic returns.
Misinterpreting history
Many commentators emphasised the importance of reinvested income to long-term returns, from which they jumped to the non sequitur that investing for income was the way to maximise returns. The flaws in this idea are firstly that investors can’t benefit from compounding if the income is not reinvested. Secondly, the benefit of compounding comes from extracting the income of mature, high-yielding investments and reinvesting it not in the same companies, but in immature growth companies.
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Nevertheless, the flood of money into high-yielding shares encouraged managements to pay unsustainable dividends, pushed up share prices and created the illusion of success for many years before it ran out of momentum. As the Neil Woodford debacle showed, the tide was going out for income investing long before the pandemic struck.
Many income-fund managers crowded into the same high-yielding stocks, notably Shell, HSBC and Vodafone. But the shrewder ones focused on companies with moderate but growing yields, rather than high but static ones. Notable among these are Charles Luke and Iain Pyle, managers of the £530m Murray Income Trust (LSE: MUT). Full disclosure: MoneyWeek’s editor-in-chief, Merryn Somerset Webb, sits on the board).
Its shares have returned 30% over five years (far ahead of the FTSE All Share’s 8.5%), trade on a 5% discount to net asset value, but still yield 4.7%. Luke emphasises the importance of “high-quality companies with strong competitive positions, robust financial characteristics and experienced management.
Diversification is helped by having up to 20% of the portfolio listed overseas, a broad range of companies and the avoidance of exposure to any one economic scenario”. The top-20 investments include no banks, no oil majors other than Total (no 16), no Vodafone and no retailers.
Betting on long-term growth
More importantly, the portfolio has barely changed since the start of the year. There has been little or no whitewashing by disposing of embarrassing mistakes.
With companies such as Diageo, Aveva, Unilever and RELX in the top ten, long-term growth is well represented. Healthcare comprises 15% of the portfolio (AstraZeneca, GlaxoSmithKline and Roche). Murray has large holdings in BHP and Rio Tinto.
With a solid record and a sensible portfolio, it is not surprising that Murray Income has been chosen by the directors of Perpetual Income & Growth Investment Trust, the troubled trust previously managed by Invesco, as its merger partner. This should result in cost savings for Murray Income and provide new investors with an opportunity to buy at an attractive price.
UK equity income won’t return to its previous level of popularity, but rumours of its death have been exaggerated. The UK faces significant uncertainties, but valuations of quality British equities were low in absolute and relative terms before the crisis and are even cheaper now. Having ridden the down cycle better than most rivals, Murray Income should profit from the upswing.
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