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Beware Dividend Concentration Among UK Large Caps

Updated: May 18, 2022

From Seneca Investment Managers' public marketing material. Seneca is now part of Momentum Global Investment Management.

Much has been written about dividend concentration among UK large caps of late. According to a recent article in Investment Week, more than half of the 79 funds in the Investment Association’s UK Equity Income sector derived over 40% of their income from their largest ten holdings. Furthermore, according to an article in Money Observer, half of FTSE 100 dividends this year will come from just seven companies. These figures reflect extreme concentration risk and should be a concern for investors in UK large cap income funds.

"A search for income does not need to be confined to the UK Equity Income sector"

That said, although dividend concentration may have increased somewhat in recent years, it is not particularly out of line with history. According to our analysis, dividend concentration was lower in 2016 than in 2006, 2007 and 2010. This can be seen in the chart below.

But fear not, help is close at hand. Venture into the mid cap space, and you can find plenty of decent yielding stocks. According to an April article in Investors Chronicle, “Analysis of the FTSE 350 reveals 117 companies with a trailing yield over 3.5 per cent, and even if we tighten up our selection criteria to those with strong cover of at least two times and PE below 13, we are left with 35 companies that pay a healthy dividend.”

In the UK equity segment of our multi-asset funds, we have a focus on mid caps. This is principally because over time mid caps tend to perform better than large caps, both in terms of returns as well as volatility-adjusted returns (since 1998, the FTSE 250 index has beaten the FTSE 100 index by 5%pts per annum).

But this is not the only reason. Mid caps are under-researched, so stock picking opportunities abound. Furthermore, as mentioned, you can find decent yields in the mid cap sector.

Our UK stocks, most of which are mid caps, on average yield 4.3% compared with 3.0% for mid caps in general. You may think we are sacrificing dividend cover but this is not the case. Average coverage for our stocks on a forward looking basis is 1.9 times compared with 2.1 times for the mid cap universe (and with 1.6 times for large caps!) Nor are we sacrificing quality: our return on equity is 21.4% on average compared with 13.8%.

According to Trustnet, the median fund yield in the IA UK Equity Income sector at the end of May was 3.9%. Furthermore, the median FE Risk Score for the sector was 85 (this means that on average, the volatility of funds in the sector was equivalent to 85% that of the FTSE 100 index). Finally, the median two-year fund performance was 13.8%.

A search for income does not need to be confined to the UK Equity Income sector though. Comparing these numbers with those of our CF Seneca Diversified Income Fund reveals some interesting results. Our fund yields 4.7% versus the median income yield of 3.9% for the IA UK equity income sector. Ah, but that’s because it is sacrificing total return, I hear you say. Not true. Two year total return has been 16.6% versus 13.8%. In that case it must be because the fund is more volatile. Again, no. The fund’s FE Risk Score is 43 half that of the UK Equity Income sector average!

The merits of a multi-asset approach in general and of our fund in particular are, we think, obvious.

Published in Investment Letter, June 2017

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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