Europe has been behind other economies in terms of its recovery and so it could offer opportunities for investors in terms of dividend growth in equities.
So what are the best ways to access income in Europe?
Richard Hodges, head of high alpha fixed income at Legal and General Investments, says the search for income has been difficult in Europe, with investors being pushed down the route of subordination to generate good levels of income.
The manager, who also runs the Dynamic Bond fund, has been buying subordinated financial debt – tier-one bonds that are callable before or in 2017 – with yields typically between 3.5-4.5 per cent.
Buying short-duration assets with an attractive yield, he says, helps maintain an attractive income distribution and positions him to reinvest at higher rates in the future.
He has also been buying subordinated debt from investment grade companies, such as water utilities companies and Heathrow, in double BB rated bonds yielding roughly 3-4.5 per cent.
Mr Hodges has been buying peripheral government and corporate debt, on the view these are attractive from a yield perspective.
Portuguese government bonds have been “the single strongest bond market returns year to date,” with 5-year bonds yielding 3.7 per cent, much higher than core European government debt.
The manager adds: “On a relative basis, peripheral European debt markets have become more attractive, because the volatility of these markets is much lower now.”
Will James, investment director at Standard Life Investments and manager of the SLI European equity income fund, says that investors are still cautious on Europe and choosing to access the market through bonds.
He explains that in spite of a strong equity run, there is still approximately 40 per cent of large-cap European companies where the dividend yield is much higher than the corporate bond yield.
He says: “Investors have been happier to invest further up the balance sheet and get the coupon and the surety of capital, rather than taking the risk of a higher yield, but more volatile capital exposure through buying equities.”
The European equity market yields roughly 3.3 per cent and Mr James expects a mid to high single digit rate of dividend growth this year.
“In Europe, you are more likely to see a degree of top-line recovery in the next 12-18 months and so investors would be better served by locking in and securing a high dividend yield and the prospect of capital growth, as companies benefit from a recovering global economy.”
Lowes Financial Management investment analyst Paul Milburn says that within Europe, the firm’s favoured asset class for income generation is equities.
He says: “Corporates, generally, have healthy balance sheets along with strong free cash flow yields. This enhances the opportunity for dividend growth moving forward.”
Mr Milburn says that dividend growth is a key contributor to equity income performance, as it can increase the possibility of shares re-rating.
