Trevor Law: Take a global approach to investing

Mar 11 2010 By Trevor Law

With savers still struggling to find decent returns on deposit accounts and interest rates likely to stay low in the UK for the foreseeable future, the pressure to find an alternative, reliable source of income has been growing.

Interest rates fell from five per cent to 0.5 per cent in rapid time as the credit crunch hit, potentially reducing savers’ income by 90 per cent.

A traditional way for investors to generate income has been through dividends from shareholdings, often through a UK Equity Income fund.

These have performed very well over the years with the average fund returning 324 per cent over the last 20 years including dividends.

With share prices still not recovered to their 2007 peak, many of these funds are yielding between five per cent and six per cent per annum – much higher than any bank or building society deposit.

The theory is that the income will increase at least in line with inflation reflecting rising dividends.

At the same time, the investment is likely to be less volatile than the average equity “growth” fund as the shareholdings will be with large, established companies with steady cashflows – the likes of BP, Shell and Tesco whose share prices are likely to more stable during market downturns.

However, the credit crunch and recession have significantly reduced the number of British companies making significant dividend payments.

The major banks used to offer a consistent source of dividends. This has reduced to a trickle.

It has now got to the stage where just six companies account for nearly 50 per cent of all dividends from the whole of the UK market.

As the UK market for dividend income comes under pressure, other markets elsewhere are demonstrating strong signs of expansion.

One of the benefits of globalisation has been a more widespread adoption of a dividend culture.

This is particularly true of regions that previously had a reputation for failing to appreciate the income needs of shareholders.

Asia-Pacific markets, for example, have traditionally attracted the more adventurous investor looking for growth opportunities and willing to accept additional risk to achieve it.

For many years most companies in the region focused on generating growth and re-investing profits to expand their businesses. Many now choose to return profits to their shareholders in the form of greater dividends.

The Asian crisis of the late 1990s led to a great deal of soul searching and much higher standards of corporate governance and transparency emerged as a result.

Companies within the region have not suffered the same structural problems as many in the West over the last couple of years. Their banks, for example, have followed much stricter lending criteria.

They have avoided the liquidity problems of their Western counterparts for the most part and have not been forced to rely on government hand-outs. This puts them in a much stronger position to pay dividends. On the flip side, this means that fewer Asian companies in general have high levels of corporate debt again strengthening their ability to pay dividends.

Another area where investors for income have traditionally shied away from is continental Europe. This probably reflects a long held British reluctance to invest in European countries. It is interesting that of all the major regions, Europe produced the best stock market returns over the last ten years while the amount held by UK investors in European funds has fallen significantly.

Europe boasts three times the number of high yielding stocks than the UK and a far lower reliance on income from banks. A larger and more diverse universe of high yielding stocks currently presents a far greater opportunity to grow income on the Continent than in the UK. The last two or three years have seen the launch of several fund concentrating on generating income from European shares.

The ownership of European companies has become more diverse. International institutional shareholders expect dividend payments, while companies controlled by government or families are becoming among the most aggressive in terms of increasing dividends - a big change from the past, when many companies hoarded cash to build bigger empires.

Funds from investment houses such as Newton and Invesco Perpetual are attempting to benefit from this trend. They are generating yields in excess of four per cent per annum by investing in companies like Roche, Total and Nestle.

There are also an increasing number of funds concentrating on generating dividends from investing in Japan and on a global basis. This gives investors a greater choice and much better opportunities to diversify to reduce risk.

There will still be a place for UK Equity Income funds in income-seeking investors portfolios. With the likes of Neil Woodford at Invesco and Adrian Frost at Artemis both operating in this area, it would be foolish to abandon it altogether. But the benefits of increased diversification and better dividend potential will lead many to hold increasing levels of equity income funds from around the globe in the future.

-Trevor Law is a director with Montpelier Group (Europe) , the privately-owned independent financial advisers located near Solihull. E-mail: tilaw@montpeliergroup.com