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Equities versus bonds as interest rates rise

Although bond yields are higher than the dividend yields, they may not provide the same inflation mitigation as the stock market. However, investors need to ensure they’re in the right areas, says the BlackRock World Mining team.

For the first time in more than a decade, gilt yields are higher than the dividend yield for the FTSE All Share.[1] This creates a new landscape for dividend investors, one where there is real competition for investors’ capital between bonds and equities. What role can dividend paying equities play in this environment?

The first point to note is that while the yield on both UK government bonds and the UK stock market is relatively high, it is below the current level of inflation. A 10-year government bond currently has a yield of 4.3%,[2] while the FTSE All Share index has an aggregate dividend yield of 3.7%.[3] Inflation is running at 7.3%.[4] This means investors who are only receiving the income are losing money in real terms.

Inflation is expected to drop, with the Bank of England saying that it will reach its 2% target by early 2025.[5]  However, there are no guarantees, as the past 12 months have shown. In the meantime, investors could see a short-term erosion of the purchasing power of their savings if they don’t take steps to protect themselves against inflation. 

For conventional UK government bond investors, this is a problem. The income will not grow in line with inflation, and while the capital is repaid at the end of the term, it also has no protection from inflation. For investors in shares, the outlook is slightly different. Companies may be able to raise their prices to reflect inflationary pressures, which in turn can be passed on to their shareholders in rising dividends. The most recent Computershare Dividend Monitor, which measures dividends in the UK market, showed dividends growing at an underlying rate of 5.6% in the first quarter of 2023.[6]

However, this is not universal. Companies may have no pricing power, perhaps because they operate in a competitive industry, with low barriers to entry, or because they have a difficult period of trading performance. This will leave them unable to raise costs and their profitability – and therefore their ability to pay dividends – may weaken. Investors need to be focusing on those companies that have the power and inclination to raise dividends over time.

Finding dividend growth companies

A recent report from independent trust analyst Stifel found that there are currently 34 trusts investing primarily in equities with a dividend yield of 4.0% or higher.[7] The BlackRock World Mining trust is one of those trusts, with a current yield of over 6.3%. We have built up a long-term track record of paying a high and rising dividend to investors. Our view is that there are certain crucial elements in finding companies likely to pay a rising dividend.

First, we want to see that a company is paying a dividend out of growing revenues, rather than jeopardising its financial security to pay cash to its shareholders. We see this at the moment with the mining sector, where companies have worked hard to strengthen their balance sheets and been prudent on borrowing. As commodity prices have risen, this has put them in a stronger position to pay dividends to shareholders.

Equally, we also need to ensure that a company is in a good position to grow its dividend over time. This means gravitating to those companies with the capacity to deliver stronger earnings growth over time. These are companies with a strong ‘moat’ for their business, a good market position and pricing power. If a company can’t grow its earnings, it can’t grow its dividend in the long-term.

As fund managers, we want to see that a management team has the inclination as well as the ability to pay a rising dividend over time. That means we like to see a compelling track record that shows the management team is committed to rewarding shareholders in this way. This is not a given. Some management teams have proved reluctant to distribute capital to shareholders.

We believe these qualities will be particularly important at a time when equity investors increasingly need to compete with bonds. Equities have the potential for long-term growth in dividends and capital, which should be a bulwark against inflation. However, it is not assured, and as investors, we need to pick with care.

For more information on how to access the opportunities presented by the mining sector, please visit www.blackrock.com/uk/brwm

Risk warnings

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

BlackRock World Mining Trust specific risks

Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.

Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.

Emerging Markets: Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.

Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.

Gold / Mining Funds: Mining shares typically experience above average volatility when compared to other investments.  Trends which occur within the general equity market may not be mirrored within mining securities.

Important Information

In the UK this is issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

This document is marketing material. The Company is managed by BlackRock Fund Managers Limited (BFM) as the AIFM. BFM has delegated certain investment management and other ancillary services to BlackRock Investment Management (UK) Limited. The Company’s shares are traded on the London Stock Exchange and dealing may only be through a member of the Exchange. The Company will not invest more than 15% of its gross assets in other listed investment trusts. SEDOL™ is a trademark of the London Stock Exchange plc and is used under licence.

Net Asset Value (NAV) performance is not the same as share price performance, and shareholders may realise returns that are lower or higher than NAV performance.

The investment trusts [listed below/above/in this document] currently conduct their affairs so that their securities can be recommended by IFAs to ordinary retail investors in accordance with the Financial Conduct Authority’s rules in relation to nonmainstream investment products and intend to continue to do so for the foreseeable future. The securities are excluded from the Financial Conduct Authority’s restrictions which apply to non-mainstream investment products because they are securities issued by investment trusts. Investors should understand all characteristics of the funds objective before investing. For information on investor rights and how to raise complaints please go to https://www.blackrock.com/corporate/compliance/investor-right available in local language in registered jurisdictions.

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