Tighter regulation threatens European dividend fund popular holdings, warns Fitch

Investors may like European dividend income funds, as the market’s 4.5% yield exceeds the US, UK and Japan, but Fitch Ratings is cautioning about the sustainability of payouts, particularly in many managers’ favourite sectors of telecoms, utilities and financials.

Olly Russ, fund manager at European equities house Argonaut Capital Partners, said the dividend yield from European shares of 4.5% was comfortably higher than ‘safe haven’ core government debt markets – a key drawcard for income-hunting allocators.

However, Fitch has questioned whether the yield coming from three key sectors for many fund managers is under threat from regulation.

It has urged investors “carefully to review the investment processes of European dividend fund managers [to] ensure that forward-looking analysis on dividend sustainability is at the core” of funds’ analysis.

Its analysis shows European equity income funds are heavily overweight financials, utilities and telecoms, holding a 40% exposure to these sectors on average.

European dividend funds Fitch analyses are, on average, overweight by 13 percentage points to the sectors, compared to the average of the Lipper Global Equity Europe peer group. The sectors represent 28.8% of the MSCI Europe index.

But these sectors “naturally have higher levels of regulation compared to other sectors”, Fitch adds, and this could endanger dividends in future, as demonstrated recently for utilities in Germany, telecoms in France or banks throughout Europe.

Fitch says the sustainability of dividends is “key to performance and managers need to reconcile a quality-growth focus with a dividend focus”.

It adds the standard form of analysing dividend by the yield is backward-looking – so by definition cannot account for future regulation.

“Managers need to develop a thorough strategic analysis covering barriers to entry, pricing power and structural sector trends.”

The three sector biases disadvantaged European dividend income funds as they underperformed broader European equity funds over five years by 2%, on greater annualised volatility, of 20.8% versus 18.1%.

 

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