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UK stocks: are equity income shares the forgotten giant for investors?


UK equities overall have suffered relative to global equities since the global financial crisis of 2008-09. Over this period, the strong value orientation resulting from the markets’ high weight to energy, basic materials, and financials was broadly out of favour as compared with the growth technology names that dominated global equity performance from 2009 to 2021.

As a result, investors have been abandoning the United Kingdom, specifically the UK equity income sector, en masse, according to latest research from Morningstar.

Its latest report, UK Equity Income: Dividends Aplenty or Yesterday’s Strategy? explores whether this is an interesting sector for investors as a “forgotten giant” or simply a post-Brexit basket case awaiting political developments.

“Since the 2008 global financial crisis, the economic environment has strongly favoured growth stocks,” says Michael Born, a research analyst with Morningstar. “The overall macroconditions had seen a combination of low interest rates, low inflation, and growing demand for new technologies, as well as products that reduce carbon intensity. At the same time, many value stocks have suffered from anaemic earnings growth and debt-heavy balance sheets. As a result, the equity income sector has lagged the market, with UK equities especially underperforming every calendar year since 2016.”

With value stocks underperforming the broad stock market for most of the post-global financial crisis period, UK dividend funds with their high weights to value and low weights to growth have seen poor returns and significant outflows. UK equity income had GBP 33 billion in outflows, and UK large-cap equity GBP 18 billion in outflows, since June 2016, with these numbers representing 60% and 23% of starting assets, respectively.

So what have fund managers been doing about it?

As a response to these value headwinds and the generally high concentration of the UK income universe, many UK income managers have tilted their portfolios more towards blend and growth stocks, and there is also a subset that have taken considerable small-cap bets. These funds have offered a differentiated return profile versus more traditional strategies.

As a result of this general underperformance, traditional equity income stocks are found at attractive valuations, and whilst yields have risen considerably over 2022, to the point where cash can offer attractive rates versus equities, investors are generally well-rewarded for investing at these sorts of valuations in total return terms, Morningstar said. Furthermore, dividend stocks also hold the potential for dividend growth, which typically more than compensates for inflation and could make them interesting for an income investor.

The overarching macro backdrop that favoured growth stocks from 2009-21 has now shifted, with rising interest rates globally and more expensive growth stocks coming under pressure. Although there are challenges for many equity sectors that result from this shift in the environment, there are select sectors that could benefit within the UK equity income universe of stocks.

“As a result of the UK equity market’s underperformance, traditional equity income stocks are attractively priced, such as Legal & General [LON:LGEN] (who are trading on two thirds of its five year average price-to-book with a 8% yield) and National Grid [LON:NG.] (trading under its five year price-to-earnings with 5.4% dividend yield),” Born said. “Even though yields have risen considerably over 2022, to the point where cash can offer attractive rates versus equities, investors are generally well-rewarded for investing at these sorts of valuations in total return terms.”

With high-dividend names perceived as riskier, this has intensified the flows into the growth areas of the market, with sectors like luxury brands and technology being desirable not just from a return but also from a risk perspective.

Diversification has also been hard to find in the FTSE 100, where the top 10 stocks typically make up 40%-50% of the index. In addition, many of the typical stocks in sectors like energy, banks, and tobacco have exhibited a riskier performance profile versus their history.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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