When UK fixed income yields are down, where to turn?
Income is becoming ever scarcer in a world dominated by interventionist central bank policy and sliding growth rates.
Fixed income yields have been suppressed by quantitative easing, with a significant portion of the universe now offering negative yields, while rock bottom interest rates mean cash yields next to nothing.
The historic Brexit vote has exacerbated the situation, with yields on safe haven government debt plunging to record lows in the UK, and curtailing any rise for interest rates.
Equities offer an ever-popular alternative. The Index behind the WisdomTree UK Equity Income UCITS ETF (WUKD) has recently rebalanced its holdings, reducing weights where positions have outperformed, and adding to existing positons now being flagged by the investment methodology as being relatively undervalued.
The Index screens for the top 33% of UK-domiciled companies by dividend yield, and then weights by cash dividends paid out over the last 12 months, otherwise known as the Dividend Stream, a unique WisdomTree methodology.
WisdomTree believes that focusing on consistent dividend payers delivers better returns for investors over the long term.
The WisdomTree UK Equity Income UCITS ETF reviews its holdings annually, with a number of companies seeing significant increases to their weightings at the most recent review at the end of May. The review mechanism focuses on both introducing new dividend paying companies and reweighting to fundamental value based on cash dividends.
The Index has added exposure to a number of companies with a history of delivering above average dividend yields. Currently, the Index comprises 96 constituents and represents a broad approach to accessing income in a low interest rate environment. Below, WisdomTree’s head of research, Viktor Nossek, focuses on some of the key sectors within the index that the ETF tracks.
“As part of the June rebalance the weighting in financials increased from 22% to 25%, which represents the maximum weight that any sector can have in the index. This is an excellent example of managing sector exposure through our capping methodology. The main cuts to dividends within the banking stocks have taken place and more importantly our focus on financials is broad based covering mainly insurance and asset management companies. In fact, there is only one banking stock in our index and this is broadly diversified on an international basis.”
“The largest shift in overall sector weight following the annual review has been in consumer discretionary, with the yield screening criteria and reweighting to fundamental value, both core parts of the Dividend Stream methodology, leading to the addition of new constituents. Overall the exposure to this sector rose from 10.5% to 20.5% when it rebalanced. This represents an interesting exposure given recent trends post-Brexit and is now the second largest sector weight.”
“Following the June rebalance and with the removal of a number of utility stocks the weight of the sector has fallen by close to 4% from 15% to 11% leaving it as the fourth largest sector in the index. There has also been an impact from lowering the weight of utility stocks that had outperformed on a relative basis”
“The largest reduction in sector weight has been within consumer staples where overextended valuations, especially in tobacco companies, triggered a reduction in weight.
From a cyclical perspective this reflects the fact that investors have sought out these typically defensive stocks to the point where the value argument no longer fits into the high yield criteria used within the selection process.”
A balanced exposure to UK income stocks
“Overall the WisdomTree UK Equity Income UCITS ETF has a balanced exposure to high yielding UK equities. By rewarding companies based on cash dividends paid, this creates a basket of UK dividend heavyweights covering various market-cap sizes. In fact, with large cap stocks representing 57% of the index, a 32% allocation to mid-cap stocks, and remainder in small-caps, it is clear that the investment methodology does not discriminate against the mid to small-cap segment of the market, enhancing the diversification argument. From a valuation perspective, the addition of new constituents and the reweighting to fundamental values resulted in a higher dividend yield. The index currently has a historic 12 month yield of 5.3% as of the end of June.”