A tactic to weather the dividend storm

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A tactic to weather the dividend storm hunt income yield equities funds trusts
Interactive Investor is 21 years old. To celebrate, our top journalists and the great and the good of the City have written a series of articles discussing what the future might hold for investors.

The hunt for income shows no sign of slowing, given the backdrop of record low interest rates, which along with quantitative easing have pushed savings rates to record lows.

Those seeking higher returns have sought solace in the stockmarket; for a short period, particularly between 2012 and 2014, income seekers had rich pickings, with scores of UK companies reinstating their dividend payments after repairing the damage the financial crisis had inflicted on their balance sheets.

The good times, however, never last forever and indeed since the start of 2015 dividend cuts have come thick and fast, with more than a dozen FTSE 100 (UKX) companies taking the axe to their dividends.

Given the challenges facing certain sectors of the market, most notably the oil and mining sectors, more cuts could be in the pipeline.

How to avoid 'dividend traps'

Thomas Moore, manager of the Standard Life UK Equity Income Unconstrained fund, is bearish on the outlook for the big blue chips in the FTSE 100 index.

He says: "Many of these big companies have a high payout ratio, stretched balance sheets and declining cash flows, which are all warning signs for investors that trouble is ahead."

Avoiding such so-called "dividend traps" is not the only challenge. It is also becoming increasingly difficult for investors to source income at an attractive price.

Investors have flocked to the safest payers, nicknamed "bond proxies", pushing up share prices, and as a result the starting yields on offer are now low at around 3% or below.

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With the spectre of inflation making a comeback, demand for reliable sources of income is only going to intensify further. But where should investors look?

Where to look for income

One tactic is to hunt for the "dividend kings" - shares that have grown their dividends through thick and thin. Examples of UK-listed shares that have upped their dividends for 10 years or more include Pearson (PSON) and Aberdeen Asset Management (ADN).

Globally, particularly in the US, there are plenty of dividend kings, including Procter and Gamble (PG), Coca-Cola (KO) and PepsiCo (PEP); all boast 40-plus years of dividend increases. In Europe, businesses that have increased dividends for at least a quarter of a century include Nestlé (NESR), Roche and L'Oréal (OR).

According to David Coombs, a multi-asset fund manager at Rathbones, widening the income search to shop globally for reliable dividend payers is a prudent strategy, given the various headwinds currently facing the post-Brexit UK market.

Investors who prefer collective investment can seek out funds with long records of increasing dividendsCoombs adds that he has been tilting his portfolios for a greater amount of exposure to businesses that he thinks will continue to thrive in a higher inflationary environment.

"Those that fit the bill have huge barriers to entry and are well placed to grow their earnings come what may. Examples include US firms Visa (V) and Johnson & Johnson (JNJ)," says Coombs.

Investors who prefer to outsource the stock selection to a fund manager may well consider a similar approach - seeking out funds that have long track records of dividend increases.

Investment trusts, thanks to the fact that they are not required to distribute all the income generated by their assets every year, are a superior option versus open-ended funds.

City of London (CTY) leads the pack, having increased dividends for 50 years. Other trusts that have increased dividend payments for at least 40 years include F&C Global Smaller Companies (FCS) and Witan (WTAN).

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This article was first published in our special publication 21: Twenty-one years of Interactive Investor. Download your digital copy for free here.

 

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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