Oil Spill affects UK income funds

The UK Equity Income sector had started to look as if it had put the troubles of the past two years behind it.

At the beginning of May, it was comfortably ahead of the UK All Companies grouping for the year to date as investors had sought out defensives in an increasingly uncertain economic climate. However, that all changed in May with the BP disaster.The FTSE 350 High Yield index dropped 7.6% for the month, compared to a fall of 5.8% in the FTSE Low Yield index. Much of this drop could be attributed to BP, the largest dividend payer in the FTSE 100, which tumbled 10% over the month. Its failure to stem the oil spill in the Gulf of Mexico has analysts fearing for its survival as an independent business.

For many equity income managers, BP is a key holding in their portfolio and its problems represent a significant blow. Adviser group BestInvest has calculated that up to 40% of equity income funds have BP as their largest holding. Some, such as Neil Woodford at Invesco Perpetual, had already sold out based on weakness in the oil price, but these are the exceptions. BP has pledged to retain its dividend, which currently makes up around 15% of the overall yield on the Footsie, but if the situation in the Gulf of Mexico deteriorates further, it may find its hand forced.

May was also a tumultuous month for another big dividend provider – Prudential. Its planned AIA deal was scuppered by shareholders who did not like the price it was paying for the assets and feared capital adequacy requirements from the FSA would hamper its ability to pay a dividend. As it was, the company spent almost as much on professional fees surrounding the failed merger than it did on its dividend last year. Its shares have rallied since the deal was called off, but are still flat on the start of May.
Elsewhere, BT pleased markets by committing itself to a “progressive” dividend policy over the next three years. Storage group Big Yellow also surprised by resuming its dividend on the back of a stronger outlook while engineering group Aveva doubled its final payout.

The weakness in BP pushed the UK Equity Income sector below that of the UK All Companies grouping for 2010. The average equity income fund has now dropped 2.72% over the year to date, compared to a fall in the average UK All Companies fund of 2.21% and in the average UK Equity Income & Growth fund of 2.62%.