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Why are investors looking to UK equities?

1:58 p.m./17 October 2016
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Investment professionals are turning to life insurance and telecom stocks as fears mount over insufficient dividend cover in the energy-heavy FTSE 100.

With bonds offering consistently low or negative yields, a combination of dividend payouts and the potential for capital growth from equities looks attractive to income-hungry investors.

The FTSE 100, from a growth perspective, appears particularly robust. On October 7 it was up nearly 16 per cent year to date in sterling terms, in part flattered by the currency’s recent weakness, which has aided the numerous dollar earners in the index.

The latest Capita Dividend Monitor appeared to provide good news for income investors, finding that UK dividends had “exceeded expectations” in the third quarter with the total payout rising 1.6 per cent year on year to £24.9bn.

But it warned that much of this could be attributed to the fall in sterling, adding: "Beneath the surface, dividend growth was rather disappointing".

Indeed, some specialists have significant concerns about the sustainability of dividend payouts, with only a few FTSE 100 names appearing solid.

Major oil names, for example, offer aggressively high dividend yields, with BP on some 6.8 per cent and Shell above 7 per cent at the end of September, but sector turbulence is dissuading prospective investors.

“Payouts on energy companies remain large despite massive revenue declines,” said Namrata Nanda, an investment specialist at research name FE.

“However, it may not be long before they cut their dividend payments or fund their distributions through debt.”

This problem is not exclusive to oil companies. Ms Nanda noted that, for the FTSE 100 overall, the dividend cover of the payout ratio was now “well over” 100 per cent, implying companies were already paying out more than they earn.

Caution when investing

As such, a sense of caution appears evident toward beaten-up sectors. Dan Farrow, a chartered financial planner at SBN Wealth Management, praised the UK’s major supermarkets – including Tesco, which recently enjoyed a strong set of results – but warned other sectors seemed unpredictable.

“Perhaps we should be looking at the oil and gas sector but commodities are still suffering from oversupply,” he explained.

He added that housebuilders were enjoying a “mini renaissance” in terms of performance, but warned these “just don’t operate in a stable environment”.

Mr Farrow, instead, is backing insurance companies such as Aviva and Standard Life, in part because of their “progressive” dividend policies, focused on increasing payouts to shareholders.

Amanda Tovey, head of direct equities at investment management firm Whitechurch Securities, also backs this sector, saying it is “currently unaffected” by depressed bond yields.

She also believes utilities companies such as SSE and National Grid are paying attractive dividends, though issues around ageing infrastructure and future regulatory intervention could emerge.

Meanwhile, Morningstar senior equity analyst Allan Nichols is favouring telecom names Vodafone, BT Group and Sky.

“While each has some short-term issues that have affected market sentiment toward their stocks, we believe each company can overcome these issues,” he said.

“Demand for connectivity between people and the internet continues and data usage is increasing, which is helping offset declining prices for voice and SMS.”

With yield appearing increasingly scarce across asset classes, FTSE 100 dividends will remain under close scrutiny.

Sustainability of these payouts will remain a concern – though loose monetary policy may be a source of some relief, according to Ms Nanda.

“Funding dividends through debt, while not ideal, seems more plausible given the extraordinarily low borrowing costs,” she said. “As long as the low interest rate environment persists, these high yields look set for delivery.”

David Baxter is deputy news editor for Investment Adviser