Income investors are taking a ‘strategic risk’ by focusing too narrowly on UK stock markets, according to the latest forecasts by Sarasin & Partners.
Their biennial Compendium of Investment - now in its 20th year – predicts that dividends are likely to grow at 1.5% a year over the next seven to 10 years; but this will be significantly less than the 2.5% growth in dividends it is expecting from global stock markets over the same period. This figure is for “real” dividend growth, after inflation.
This forecast reflects past performance. According to Sarasin, over the past 90 years real dividend growth in the UK has be 2% a year, compared to 2.9% in the US.
Presenting this report Richard Maitland, a partner at Sarasin & Partners, said there was genuine concern about the concentration of private client funds in UK Equity Income funds, which could lead to poorer performance long term.
Sarasin is a fund manager specialising in managing charity assets. He said he believed that this UK-focus partly explains why returns from smaller charity portfolios have typically underperformed those of larger charitable foundations, which tend to have more exposure to global equity markets.
Sarasin said this difference in dividend growth can be explained by looking at the composition of different stock markets.
Is UK Equity Market A Sensible Option?
According to MSCI data – used in the Sarasin report – companies in the information technology sector make up 14.2% of global stock markets. But this sector accounts for just 1.5% of the UK market. (In the US they account for 20.7% of the market).
In contrast energy companies make up 6% of global markets, but have twice the weighting in the UK market – at 12.3%. This is largely concentrated in oil and gas – with the majority of this exposure being in two giants of the UK stock market: BP (BP.) and Royal Dutch Shell (RDSB).
Maitland said: “If you are looking to the future and thinking where growth will come from you have to think whether this is a wise position to be in. Will oil and gas or technology be the drivers of future economic growth? [This imbalance] suggests the need for some element of investment in other markets, to ensure a broad enough and more balanced universe.”
He said concerns about this imbalance caused his team to invest more globally a decade ago, when the banking sector accounted for nearly one third of the dividend income generated on UK markets.
“We didn’t know that the banking sector was going to collapse in the way it did. We just thought that strategically having one third of your income coming from one sector was probably not that wise,” he added. Similar problems were also highlighted following the Macondo disaster in 2010, when BP suspended its dividend payments. As a result UK investors saw their income fall by around 12% the report said.
The report says that it is this dividend income growth that, all other things being equal, will drive the future value of the stock market.
Future Stock Market Predictions
The report revealed Sarasin’s assumptions for future returns over the next decade.
The fund manager said it did not share the negative view of others that global growth would falter. Over the next seven to 10 years Sarasin said they would expect global real GDP growth of 2.5% a year. In its forecasts it is assuming inflation to average at 1.5% a year.
For UK and international equity markets it is expecting a ‘trend’ return 6.4% - although this is before inflation and any manager’s costs are taken into account. UK property is expected to produce a total return of 6%, and alternative a return of 5.5%.
In its first Compendium of Investment Sarasin predicted long term investors should expect ‘real returns’ of around 4.4% a year – after inflation. This was significantly lower than the returns investors had been enjoying. At the time the average charity portfolio had produced returns of around 12.7% a year, or 7.9% after inflation over the previous decade, and a staggering 17% a year (10% after inflation) over the previous 20 years.
Maitland added: “At the time there were some raised eyebrows at our prediction. And in the last few years of the 1990s, equity returns were high on the back of the tech boom. But from a strategic perspective we were correct to aim so low.” In the period since this first report equity investors with a diversified portfolio have enjoyed returns of around 5% after inflation.
