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Can ETFs offer a Woodford alternative?

Can ETFs offer a Woodford alternative?

With 2016 having proved such a disappointing year for so many people, little sympathy was extended to UK equity income investors.

They may not have endured a truly terrible year, but they did materially underperform the UK market more broadly. The FTSE UK Equity Income index gained 12.6% in 2016, compared with 16.8% from the FTSE All Share index.

Aggravating this, income investors probably did not expect to lag the market. The large-caps that are staples of their portfolios outperformed mid and small-caps, and all the dividends they receive in dollars became more valuable when sterling plummeted after the Brexit vote.

Falling behind

Strip out that Brexit effect and the year was even worse for UK equity income. In its Global Dividend index, Janus Henderson tracks dividend trends in a common currency – the US dollar – to assess the underlying health of corporate distributions.

In 2016, UK dividends fell by 3% – including a 13.7% drop in the third quarter last year immediately after the June referendum – while remaining flat for the year internationally.

That low base, of course, is now flattering year-on-year comparisons. In the third quarter of this year, Janus Henderson reported in November, the UK enjoyed the fastest underlying dividend growth in the world.

UK dividends grew by 17.5% in the quarter, excluding the effects of special dividends and currency movements, compared with a global average of 8.4%.

‘UK dividend growth has been far behind global peers over the last year both owing to the devaluation of sterling following the Brexit vote and to a wave of dividend cuts and cancellations from some of the UK’s largest listed companies, particularly in the mining sector,’ Janus Henderson commented.

‘With the anniversary of the pound’s decline now behind us, it is no longer acting as a drag on headline growth in dollar terms. Moreover, higher commodity prices have combined with more streamlined businesses to deliver soaring cash flows for mining companies. Dividends from the sector surged as a result, and at a greater rate than investors anticipated.’

Digging for divis

Rio Tinto has doubled its payout in distributing its largest-ever interim dividend, for example, while BHP Billiton tripled its dividend year-on-year and Anglo American restored its payment to shareholders six months earlier than expected. Compass Group, the contract caterer, also paid a large special dividend in the period.

Some investors may not have expected this bonanza, as Janus Henderson claimed – UK dividends had after all fallen by 3.5% on a headline basis in the second quarter – but did any of the UK equity-income ETFs have methodologies that captured this third-quarter renaissance?

Mining minus

The BMO MSCI UK Income Leaders ETF focuses on quality as well as yield, so will have missed the miners. Its screening process first identifies the top half of the MSCI UK index by return on equity, stable year-over-year earnings growth, and low financial leverage.

It then buys the highest-yielding half of those stocks, rebalancing twice a year. It thus owned the likes of British American Tobacco and 3i Group rather than natural-resources companies.

The Lyxor FTSE UK Quality Low Vol Dividend and PowerShares FTSE UK High Dividend Low Volatility ETFs likewise tend to eschew miners due to their volatility mandates. The SPDR S&P UK Dividend Aristocrats ETF similarly avoided miners given its demand for a 10-year record of increasing or stable dividends.

The iShares FTSE UK Dividend Plus ETF instead targets the top 50 stocks in the FTSE 350 by their one-year forecast dividend yield, so will not capture surprises like those from the miners earlier this year. Going into the third quarter, then, it had more exposure to financials and oil than the large-cap miners.

The WisdomTree UK Equity Income ETF also prioritises yield, but in this case opts for the highest third of UK stocks by historic dividend yield in its WisdomTree International Equity index, equivalent to around 100 names. This approach did leave it with major positions in miners like BHP Billiton and Rio Tinto during the third quarter.


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