Invesco Perpetual

With high historic dividends and then an accounting shock, Tesco caught investors off-guard. Reuters

If you thought finding a needle in a haystack was hard, try identifying a low risk asset class that promises to provide juicy returns in Europe next year.

As the ECB moves closer to implementing more aggressive measures to boost growth, bond yields look unlikely to pick up imminently.

Commodity prices are tumbling and rates appear well and truly anchored at—or at least near—record lows for the foreseeable future.

The equity market is broadly considered to be most likely to offer returns, but even that could turn out to be hazardous, if investors tumble into what Invesco Perpetual Head of U.K. Equities, Mark Barnett dubs “the yield trap.”

Mr. Barnett – who earlier this year succeeded Neil Woodford as head of U.K. equities at Invesco Perpetual — says that some  companies yielding high dividends are “wicked temptresses.

Investors continue to succumb to the temptation of high but unsustainable yield – they fall headlong into the so-called yield trap, discovering after purchase that the underlying company’s high profits the previous year were not repeatable and that the shares were cheap for a reason,” he says.

Invesco Perpetual manages £75.4 billion ($118 billion).

He points to Tesco PLC as an example of a company with historic high dividend yields that caught investors off guard with recent profit warnings.

The U.K.’s biggest retailer has in recent month come under fire for actions that led to a £263 million ($413 million) overstatement of its forecast fiscal-first-half profit. Its chairman has stepped down, it has issued a profit warning and shares have fallen a staggering 44% since the start of January.

So how does one avoid getting caught out by something like Tesco?

Mr. Barnett says it comes down to “high levels of due diligence, energetic tyre-kicking, hard-nosed rigorous cross examination of expert input followed by healthy internal debate.”

He also says that while it is true that equities continue to look attractive relative to other asset classes, valuations still look lofty where share prices do not appropriately anticipate the risk to earnings and cash-flows that companies are facing.

“I place significant importance and value on the companies in the market which offer visibility of revenues, profits and cash-flows in this low growth world and which are managed for the sole purpose of delivering shareholder value in the form of a sustainable and growing dividend,” he says.

According to Morningstar, top holdings in the Invesco Perpetual Income fund, which Mr. Barnett manages, include British American Tobacco PLC, AstraZeneca PLC, Imperial Tobacco Group PLC, Roche Holding AG. BAE Systems PLC, BT Group PLC and GlaxoSmithKline PLC. Morningstar shows that the fund has returned 10.74% year-to-date and offers a 12-month yield of 3.53%.