For most of the decade before 2022, the case for equity income made itself. Bank Rate sat close to zero. 10-year gilts yielded less than 2%, and often less than 1%. If you needed an income from your capital, a portfolio of dividend-paying shares was one of the few places to find one.
That world has gone. Cash deposits and short-dated gilts now pay more than 3%, and you can lock in a yield above 4% on high-quality corporate bonds without taking any equity risk at all. The question we are asked most often by trustees and their advisers is a fair one: why bother with equity income now?
Our answer has three parts.
Cash pays today. Dividends can grow.
A deposit or a short bond pays a fixed amount. When it matures, you reinvest at whatever rate the market offers. If rates fall, your income falls with them.
A dividend works differently. It is a share of the profits of a business, and if the business grows, the dividend can grow too. Take two portfolios of £10 million. One sits in cash at 4%. The other is invested in UK shares yielding 3.8%. In the first year the cash pays slightly more. But if the dividends from the share portfolio grow by 5% a year, the share portfolio’s income overtakes the cash in the third year, and by the tenth year it pays around £590,000 against the cash’s £400,000, assuming the deposit rate holds.
That growth is not assured. UK dividends fell by more than a third in 2020 and took three years to recover. That is why the second part of our answer matters more than the first.
Higher rates have changed which dividends are safe
When money was nearly free, a company could borrow to keep its dividend going and pay very little for the privilege. Many did. Some listed landlords, utilities and consumer businesses paid out more than they earned in cash for years, and covered the gap with debt.
That debt is now coming due. A company that borrowed at 2% in 2020 and must refinance in 2027 may pay 6% or more on the same money. The extra interest comes straight out of the cash that would otherwise fund the dividend.
Over the past 18 months we have gone through every holding in the UK Equity Income Strategy and mapped its debt maturities against what refinancing would cost at today’s rates. It was slow work and it changed the portfolio.
We sold our position in a listed landlord whose bonds maturing in 2027 would cost almost three times their current coupon to replace. Its dividend looked safe on paper. It did not look safe once we redid the interest bill. We also reduced a consumer brands business that had funded buybacks with borrowing.
On the other side, we added to two general insurers. Insurers hold large portfolios of short bonds to meet future claims, and higher rates have lifted the income on those portfolios sharply. We also bought a water company after its price settlement for 2025 to 2030 gave it a clearer view of what it could earn and spend.
A yield is only a board’s statement of intent. Our work is judging which boards can afford it.
What income does inside a portfolio
The third part of our answer is about discipline rather than arithmetic.
A company that commits to a dividend has to find the cash every six months. That limits how much it can spend on large acquisitions, vanity projects and empire-building. It forces management to choose. Over long periods we think that pressure leads to better use of capital, and the record of UK shares supports it: by most measures, reinvested dividends account for more than half of the total return from the UK market over the past 30 years.
Income also changes how investors behave. Trustees who receive a steady cash return are less likely to sell at the bottom of a market. Charities can plan grants. Pension schemes can meet payments without selling shares when prices are low. A portfolio that produces cash gives its owners room to be patient.
Where we are finding it now
The FTSE All-Share Index yields around 3.5%. The UK Equity Income Strategy yields around 4.4%, and we have built that from companies whose dividends were covered by free cash flow at least 1.5 times last year.
The yield comes from a wider range of businesses than many people expect. Alongside the insurers and the water company, the portfolio holds a building materials distributor, two medium-sized engineering firms that sell into the defence and energy supply chains, a software business that serves accountancy practices and a food producer that has raised its dividend through every year of high inflation.
What we are avoiding is just as telling. We do not own the highest-yielding shares in the index for their own sake. In our experience a yield above 8% is more often a warning than an opportunity: the market is usually telling you the payment will be cut. We would rather own a company yielding 3% that can raise its dividend by 8% a year than one yielding 9% that cannot hold it.
The case, restated
Higher rates have made cash and bonds a real alternative, and we are glad of it. Our own clients hold both, often with us. But a deposit cannot grow its income, and a bond cannot raise its coupon. A well-chosen portfolio of UK businesses can do both, provided you are careful about which dividends you trust.
That care is the job. It is also why we run the strategy with 35 to 45 holdings rather than a few hundred. We would rather know each company well enough to tell you why we expect its dividend to be paid than own enough of them to stop asking.
This article reflects the author’s views on the date of publication. It is not investment advice or a recommendation to buy or sell any security. Capital is at risk and past performance is not a guide to future returns.