The forecast for UK dividends has improved dramatically in 2021 as the country starts to recover from coronavirus and no longer faces the risk of a no-deal Brexit, however, ETF investors have limited choice to capture the potential rebound.

According to data from Link Group, UK dividends dropped a massive 44% to £61.9bn in 2020, the lowest annual total since 2011, as companies reeled from the impact of the coronavirus pandemic.

Overall, the rapid spread of coronavirus and subsequent market correction at the end of Q1 2020 led to two-thirds of UK companies cancelled or cut their dividends between Q2 and Q4.

As Susan Ring, CEO Corporate Markets of Link, said: “This was a dreadful result for UK investors, especially those for whom dividends are a major source of income.

“UK payouts have been more severely impacted than in most comparable countries because of their heavy concentration in the hands of just a few very large companies, mainly in the oil, mining and banking industries – all sectors that have had to cut dividends steeply.”

While a full-blown recovery has been put on hold by a third lockdown, there have been some signs of light at the end of the tunnel.

Highlighting this, payment declarations came to £1.1bn in 2021, as of 29 January, with a further £91m worth of dividends restored versus just £27m of cuts, according to data from AJ Bell.

Russ Mould, investment director at AJ Bell, added: “While there is no denying that the economic backdrop is a very difficult one – and that hopes for a rapid bounce back in activity are fading a little – firms’ ability and willingness to make dividend payments suggests that they have planned for a worst case scenario and managed their costs and husbanded their resources and cash accordingly.”

UK dividend ETFs

As a result, UK dividend ETFs look well placed to benefit from the improving economic outlook, however, investors just have three ETFs to choose from.

The $939m iShares UK Dividend UCITS ETF (IUKD), the $133m SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV) and the $10.4m WisdomTree UK Equity Income UCITS ETF (WUKD) are the only strategies to offer direct exposure to higher yielding UK companies but they achieve this in different ways.

Looking at the largest ETF first, IUKD tracks the FTSE UK Dividend+ index which offers exposure to the 50 highest yielding companies in the FTSE 350 index.

Launched in 2005 and rebalanced semi-annually, companies are weighted on their one-year forecast for dividend yields which leads to stocks with high dividends being included in the ETF.

While this methodology is simple and delivers a distribution yield of 4.03%, as at 4 February, it can expose investors to dividend traps by not taking into account the underlying fundamentals of a stock.

Effectively too good to be true, a dividend trap is when a stock’s high yield becomes unsustainable due to weak fundamentals.

Meanwhile, UKDV tracks the S&P UK High Yield Dividend Aristocrats index which offers exposure to the 35 highest dividend-yielding UK companies from the S&P Europe Broad Market index.

Where UKDV differs from IUKD is it only includes companies that have either increased or maintained dividends for at least seven consecutive years.

UKDV currently has a dividend yield of 4.2% and is heavily exposed to financials (30.2%) which is similar to IUKD (34.1%).

For AJ Bell’s Mould, the banks will be particularly important this year as analysts expect the sector to provide over half of the total dividend growth forecast for the FTSE 100 this year which translates to a £5.6bn increase.

Finally, WUKD offers investors exposure to UK companies in the top 33% by dividend yield in the WisdomTree International Equity index.

Stocks are also screened using the quality and momentum factors and receive a higher weighting in the index if they score well from a factor perspective.

WUKD has been the best performing ETF of the three over the past five years returning 2.5% versus 2% for UKDV and 1.2% for IUKD which highlights how seriously the sector was hammered during the coronavirus turmoil.

UK dividend ETFs are yet to capture the imagination of investors with IUKD the only product to see assets grow over $500m. Instead, investors continue to look to active managers in this segment of the market but the Woodford scandal in 2019 highlights the potential risks involved with this approach.

Please note: The tool is provided by ETF Logic who shall process your personal data in accordance with their privacy policy.