How could the economic outlook affect equity income?

The impact of the Bank of England rate cut in August should help to boost investor confidence, says Miranda Seath, director of market insight and fund sectors at the Investment Association, as the outlook for inflation has improved and the peak of the rate cycle has been reached.

Although the BoE expects inflation to rise to around 2.75 per cent towards the end of the year, the figure is far from the 11.1 per cent peak in October 2022.

“The most recent inflation surge from mid-2021 through the whole of 2022 saw interest rates rise substantially from low levels, and global equity markets struggled,” says Nick Clay, head of the global equity income strategy at Redwheel.

But he adds: “Global equity income funds held up well during 2022, declining far less. This was driven by a number of factors.

“Firstly, companies who were best placed to cope with the inflation surge were the ones who have pricing power. These tended to be staples companies, utilities where the regulatory regime allows for pass-through of costs, and dominant consumer discretionary brands either in the luxury end, or with strong brands such as Inditex.

“These sectors are favoured by some global income managers, and thus helped those funds ‘suffer better’.

It's a much more benign environment for UK equity income now compared with five years ago.

Thomas Moore, Abrdn

“Secondly, the other side of the coin was avoided. Highly valued stocks, within technology especially, suffered as rates rose. Further, cyclical stocks such as industrials and financials struggled as the economy slowed in response to rising rates. Again, some income managers had avoided these areas.”

Subsequently in 2023, Dunedin Income Growth Investment Trust manager, Rebecca Maclean, highlights how 60 per cent of the total dividends paid by companies in the UK market originated from 15 companies, with cyclical industries like banks, mining, and oil and gas accounting for a significant proportion of dividends.

“It is easy, then, to see why these sectors present an attractive hunting ground for many income investors searching for yield,” says Maclean. “In an inflationary period such as 2022, when market returns were highly concentrated in energy, mining and defence sectors, this turned out to be a successful strategy for many income funds in the short term.”

But that does not mean it will be in the future, Maclean adds.