The good news is we are all living longer. Advances in medicine and healthier lifestyles have led to an increase in the average life expectancy of both males and females. Also the number of people about to enjoy retirement is set to grow by 50% over the next 20 years.
The bad news is we have to find ways of funding that retirement and longevity. But low interest rates and bond yields - the traditional sources of income – aren’t sufficient to sustain a proper living. We think an attractive alternative is equity income.
So how does the UK dividend market fare up? Headlines in the newspapers have been recently dominated by news of dividend cuts from some of the biggest names here. The likes of Rio Tinto, BHP Billiton, Rolls Royce and Barclays have all announced dividend cuts this year. This can create a large problem for income fund managers so the question remains: how do you find income in the current environment?
Firstly it’s important to maintain a diverse portfolio. One major criticism of the UK market is that it is overly concentrated in terms of income: the top 10 dividend paying stocks represent over 50% of the total market income. Owning a broad range of companies across a number of different sectors such as pharmaceuticals, telecoms, media and utilities means the Trust isn’t overly reliant on any one sector or company for its dividend; especially helpful given the current pressure on oil & gas and mining companies’ cash flows and dividends.
It’s also important to own companies whose business models aren’t necessarily dependant on the economic cycle and hence their income is subject to less volatility. The likes of tobacco company Imperial Brands, professional publisher RELX, Sky and BT are good examples, having historically paid stable and rising dividends backed by strong cash flows and robust balance sheets.
Although there are pressures surrounding dividends in some of the biggest companies in the UK market it’s not all doom and gloom. Outside the mega cap sectors we are still finding good opportunities for dividend growth. Two of the companies I own where I expect good dividend growth are Big Yellow and Victrex, the manufacturer of high performance plastics.
Big Yellow is the UK’s leading self-storage company with good exposure to London. With limited space in the capital, demand for self-storage is set to grow rapidly as the population expands. This structural growth alongside the addition of new sites by the company we hope will drive strong earnings and dividend growth over the medium term.
Victrex has been investing to add capacity to fuel new growth opportunities in medical applications such as dental, trauma and knee implants. This will help drive strong revenue growth over the long term which, combined with the high returns the company make, should significantly increase cash flow and dividends.
Finally, one of the major advantages of an investment trust like Henderson High Income is having the ability to use revenue reserves to pay dividends. Over the last few years the Trust has built up its reserves, putting a little bit of extra income away in the good years to help protect the dividend in difficult years. Although we are not in the latter scenario yet, having those reserves should give investors’ confidence in the Trust’s dividend over the long term.