A new way to find UK dividends

These are still going strong, according to the latest UK Dividend Monitor report by Computershare. It points to the fact that UK dividends rose by 11.2 per cent on a headline basis in the second quarter of this year, hitting a record £36.7bn. Dividend growth was “broad based”, with 16 out of 21 sectors reporting higher payouts. The median dividend increased, on the company level, by 5.4 per cent year on year.

UK equities are set to yield 4 per cent across the whole of 2024 and, as usual, investors can look for something even punchier via funds.

In the investment trust sector alone, the average trust boasts a share price dividend yield of 4.1 per cent, according to the Association of Investment Companies. Many promise significantly higher returns: Abrdn Equity Income (AEI) comes with a yield of 7.1 per cent and CT UK High Income (CHI) offers more than 6 per cent. 

And yet problems remain. Investors taking dividends from UK large-cap stocks in particular risk becoming reliant on a handful of sectors and individual companies. Banks are booming at the moment, with dividends up 14 per cent year on year, fuelled by HSBC (HSBA) and NatWest (NWG). However, as interest rates edge downwards, the money tap might be switched off. Meanwhile, difficulties in the mining sector are denting total payouts. 

The top five dividend payers in the second quarter – HSBC, Rio Tinto (RIO), Shell (SHEL), British American Tobacco (BATS) and Lloyds (LLOY) – accounted for 44 per cent of the total haul, with the next 10 biggest payers accounting for a further 22 per cent. Conventional UK income funds tend to focus predominantly on the biggest companies, so are highly exposed to this small pool of players. 

It might make sense to expand your source of dividends, therefore – particularly as there are some very compelling options out there.

Small pleasures

A handful of UK equity income fund managers have set themselves apart over the years by taking a ‘multi-cap’ approach. This involves using small and mid-cap shares, as well as the traditional giants, to generate dividends. This isn’t for the faint-hearted, especially as smaller company valuations have weakened notably since 2022. But such funds can generate very respectable yields, and are an easy way to shake up a FTSE-100-heavy portfolio.

Investors drawn to such funds have another reason to be optimistic: small and mid-cap shares still have a long way to rebound. They have performed well in the past 12 months, with the FTSE Small Cap index up by around 11 per cent, and the FTSE 250 up by the same amount. These indices continue to lag the FTSE 100 over a longer period, however, and could recover further now the UK economy seems to be on a steadier footing.

UK multi-cap income funds have certainly made hay in the past year, as the chart below shows. But given the inherent volatility involved, it makes sense to back a fund that is tightly focused on quality, and a team that doesn’t forgot to diversify well and manage risk.

That brings us to Gresham House UK Multi Cap Income (GB00BYXVGT82), which ticks a number of important boxes.

The Gresham House team is not afraid to look further down the market cap spectrum in the pursuit of returns, with 58 per cent of the portfolio in small caps, 7 per cent in micro-caps, 10 per cent in mid-caps and just 16 per cent allocated to large-caps (co-managers Ken Wotton and Brendan Gulston also run a UK micro-cap fund). 

The team favours companies that have an entrepreneurial edge, competitive advantages, strong balance sheets and the potential to grow profits and cash over time. This is hardly unusual but, unlike some its rivals, the Gresham House fund has managed to deliver solid returns, suggesting it is putting its words into action.

Gresham House UK Multi Cap Income’s portfolio

The fund is not aggressively concentrated, with 41 holdings in total and the top position making up around 5 per cent of the portfolio. However, there are some clear sector preferences, with financials accounting for roughly 40 per cent of the fund and business services companies making up almost a fifth. 

The team has a particular penchant for consultancies, with XPS Pensions Group (XPS), Alpha Financial Markets Consulting (AFM) and Ricardo (RCDO) all among the top five holdings. The fund has also increased its stake in FRP Advisory Group (FRP).

Ken Wotton argued earlier this year that niche business consultancies represent “one particularly bright spot” in the UK market, thanks to a combination of low valuations, interest from acquisitive private equity firms and structural tailwinds. “Investors, seeking stability and growth, can find attractive opportunities in capital-light industries like these,” he said.

XPS Pensions, the fund’s biggest position, is one good example. It had a bumper set of results earlier this year, boosted by a deal with John Lewis to provide administrative services to its pension trust. 

“But the success goes beyond this single win,” Wotton noted in June. “High client activity, strategic price adjustments to account for inflation, targeted bolt-on acquisitions and a consistent focus on new business wins have all contributed to the firm’s continued momentum.”

Consultancies are certainly piquing the interest of outsiders. Alpha FMC is poised to leave the London market after accepting a 505p-a-share deal in June, providing shareholders with a windfall of £625mn. The firm is being bought by specialist investment firm Bridgepoint (BPT).

Gresham House seems very good at spotting tempting takeover targets. Much like Stuart Widdowson of Odyssean (OIT), Wotton and his colleagues seek to apply a “private equity approach to public markets”. This can involve drawing on the expertise of colleagues in the private equity team to assess valuations, as well as building up big stakes in companies and engaging with management to spur on positive changes.

Gresham House, for example, has become the biggest shareholder in XPS Pensions via its different funds. Strategic Equity Capital (SEC), an investment trust also run by Wotton, has around a fifth of its £190mn portfolio in the company.

Some considerations

When it comes to the fund some of the usual disclaimers apply. Small and mid-cap shares can be volatile, and a UK income investor might want to hold a large-cap vehicle, or a handful of solid blue-chips, alongside it.

As we note, the team also runs an investment trust, which might look like more of an obvious bargain thanks to its share price discount of around 6.5 per cent, but it does come with the extra complications of a closed-ended fund. SEC is also a much smaller affair and operates in a sector that is currently prone to disruption, with plenty of merger and acquisition activity on the cards.

Gresham House UK Multi Cap Income might be more of a satellite holding for an investor seeking out regular dividends. However, its eclectic portfolio is an attractive counterpoint to the FTSE titans and it could do very well if and when smaller companies rebound.