Inexperienced investors keen to capitalise on these trends will probably prefer to buy into a fund, rather than purchase individual shares, as they generally provide greater diversification and a hands-on approach from experts in the field. But with such a vast array of attractive options on the market, finding the most suitable ones is no easy feat.
Back managers with solid track records
According to Laith Khalaf, senior analyst at Hargreaves Lansdown, a good starting point is to identify funds run by successful managers. “It’s best to back managers with a long-term track record of delivering robust total returns, and fortunately the equity income sector is blessed with some real investment talent,” he says.
“The big name in the sector is of course Neil Woodford, who runs Woodford Equity Income. But, likewise, there are other seasoned campaigners in the UK equity income universe with a history of outperformance.”
For example, the £667m Schroder UK Alpha Income Fund, managed by Matt Hudson, has a historic yield of 4.45 per cent, with holdings in high dividend-paying value stocks such as British American Tobacco, Royal Dutch Shell and BP.
Don’t chase yield
Another important consideration to make is how much yield you require to maintain a decent standard of living. Some funds offer mouthwatering dividends in the region of 7 per cent, although most, including Mr Khalaf, agree that something between 3.5 per cent and 4 per cent is a more realistic starting point.
In some cases, high yields can represent heavy price falls within portfolios, or an accumulation of stocks that pay out more than they can realistically afford to shareholders.
“Where income investors can go wrong is by starting with a certain yield requirement and letting that drive their share selection process,” says Todd Wenning, research analyst at Johnson Investment Counsel.
“If your yield requirement is far above the market average yield, you might end up building a portfolio of riskier securities than you'd have liked. You might enjoy a few quarters of high income, but you also run a higher risk of dividend cuts, which could impair your longer-term income potential.”
Dividend cuts rock the UK
UK investors have grown accustomed to companies slashing payouts. According to research by Share Centre, many of the nation’s biggest names spend more on dividends than they make in profits.
That worrying admission helps to explain why second quarter underlying dividends in the UK were the weakest performer among the Group of Seven leading industrialised nations.
Mr Khalaf reckons that axing dividends is “part and parcel of income investing” – and that free cash flow cover has now largely been restored, following a spate of high-profile cuts across big British companies.
