Obtaining a nice, safe income stream used to be one of the main reasons for becoming an equity investor. But not any longer. Since the outbreak of coronavirus, company dividend payments have dried up.
The latest dividend report from Link Group, which monitors payouts from UK companies, indicates that dividends for the second quarter of this year declined by 57 per cent compared with the same time last year.
‘The whole of 2020 will, without doubt, see the biggest hit to dividends in generations,’ says Link’s Susan Ring. Ominously, she adds: ‘It could take until 2026 for them to return to their 2019 level.’
It could take until 2026 for dividends to return to their 2019 level, one expert says
Jason Hollands, a director of wealth manager Tilney, agrees these are ‘tough times for income seekers’. But he is not totally despondent. ‘The UK remains the premier market for dividend seekers,’ he says. ‘While this is clearly a painful year for equity income investors, dividends should start to rise again next year.’
Here’s how to best position your portfolio for income in these difficult times.
Equities are still main income gain in town
In previous decades, attractive income was available from a range of assets, including savings accounts and government bonds (gilts). That’s no longer the case with interest rates at record lows.
Yields on government bonds have evaporated with ten-year gilts currently providing investors with an annual return of just 0.14 per cent. Meanwhile, savers are lucky if they can earn interest of more than 0.01 per cent from their bank or building society.
As a result, experts maintain that despite the cuts to dividends, equities are still the main income game in town.
Juliet Schooling Latter, head of research for fund scrutineer Chelsea Financial Services, says dividends from a typical portfolio of income-friendly UK companies will drop over the next five years from four per cent a year to around three per cent. Disappointing, she admits, ‘but that three per cent is still likely to be more attractive than income from cash, government bonds and corporate bonds’.
Not all companies or sectors of the UK stock market are created equal when it comes to paying dividends while coronavirus has suddenly made some traditionally safe income stocks look insecure.
Tom Rosser, research analyst at The Share Centre, says: ‘Dependable stalwarts for income investors such as Shell, HSBC and BT have cut dividends for the first time in decades or even generations, while those still holding out, including BP and L&G, may follow. Some traditional safe haven sectors, such as insurance and banks, are no longer so income-friendly.’
Utilities and pharmaceutical businesses look a safer income bet than financials, says Rosser, although he adds that the current limelight AstraZeneca and its pharmaceutical peers are enjoying due to efforts to find a vaccine for coronavirus are ‘more likely to generate good PR rather than profits, due to high research and development costs’. But he views utilities and pharmaceuticals as ‘the two sectors most resilient to dividend cuts’.
Rosser says investment fund Man GLG Income has exposure to several income friendly sectors with pharmaceutical group GSK a key holding. He explains: ‘It distributes income on a monthly basis and so far this year has delivered an income equivalent to around 4 per cent a year.’
A few words of context from Ben Lofthouse, manager of investment trust Henderson International Income. He says: ‘Naturally, no investor wants to see their dividends get cut, but if a reduction is in the interests of protecting a company in such unusual times it’s the right thing to do, allowing them to emerge financially stronger.’
Flexibility is key to success
Income investors should seek out fund managers who have adopted a flexible investment approach in response to the current dearth in dividends, says Tilney’s Jason Hollands.
He says: ‘I like equity income managers who have the freedom to back companies that might not be currently paying a dividend but are expected to in the near future – or are perhaps only paying a modest dividend, but have the potential to grow it from here.’
He suggests Threadneedle UK Equity Income, which he describes as ‘pragmatically managed’, investing in a mix of growth companies and dividend friendly businesses. Top ten holdings include healthcare giants AstraZeneca and GlaxoSmithKline, supermarket giant Morrisons and tobacco company Imperial Brands. The fund currently provides an income of around 4 per cent.
Finally, although searching for dividends might seem tricky at present, it is important to recognise that the companies cutting their payouts are navigating unchartered waters. A dividend reduction this year does not mean a company will not at some stage start increasing payments again.
Ben Lofthouse, of Janus Henderson, says: ‘Investors should remember that a temporary halt in dividends does not change the fundamental value of a company. That is driven more by the ability of the company to flourish and grow over the longer term. With interest rates set to be exceptionally low for the foreseeable future, shares will remain a vital source of income for investors.’
So keep calm and invest sensibly. Dividend income should hopefully return.
Income-friendly investment trusts
Many experts believe that income-orientated investment trusts are a good way to maintain a steady income in tough times.
This is because unlike other investment funds that pay out all the income they receive each year to investors, investment trusts don’t have to. They can hold back income in the good years to boost dividend payments in leaner years.
Such income reserves are proving invaluable in the current environment. James Carthew, head of investment company research at analyst QuotedData, says most trusts have enough income squirrelled away to see them through the short term, but warns that these reserves will not last forever.
He says: ‘On average, most income-friendly trusts seem to have about nine months to a year and a half’s income held in reserve. That should be more than enough to get them through the current UK dividend crisis. But a second coronavirus wave or a severe recession could strain the income resources of some of these trusts.’
Investment trust Troy Income & Growth invests in companies that have not cut their dividend, such as Unilever, Reckitt Benckiser and AstraZeneca
Ryan Hughes, of wealth manager AJ Bell, suggests investors should take a look at investment trust Troy Income & Growth.
He says: ‘The fund focuses on companies that have the ability to generate cash and pay dividends and has the likes of Unilever, Reckitt Benckiser and AstraZeneca among its top ten holdings.
‘Although the trust’s annual income is currently around 3.9 per cent, the managers have said that this will come down as they look to reposition the portfolio towards companies that offer good dividend growth prospects for the future. One investor-friendly element of the trust is that it pays a quarterly dividend.’
Carthew likes investment trust Diverse Income, run by asset manager Miton. He explains: ‘Its managers are known for their skills in picking income-paying smaller company stocks.’
Diverse Income provides an annual income equivalent to 4.6 per cent. But overall performance wise, the numbers do not look good, with losses recorded over both one and three years of 3 per cent and 7 per cent respectively.
Dzmitry Lipski, head of fund research at wealth manager Interactive Investor, recommends Bankers (managed by investment house Janus Henderson) which he says ‘aims for dividend growth greater than inflation’.
He also likes Murray International although he describes the trust as ‘an adventurous option that requires patience’. This, he says, is because ‘the manager looks for undervalued stocks, and his investment style is currently out of favour’.
Murray International, managed by investment combine Aberdeen Standard Investments, provides an annual income equivalent to 5.5 per cent.
Bankers currently yields just 2 per cent, but its overall performance numbers are strong, generating one-year returns of 9 per cent and three-year returns of 35 per cent.
…And think about investing globally
While UK equities are traditionally seen as the main hunting ground for income-seekers, investors should also look beyond these shores.
Yoojeong Oh is manager of investment fund Aberdeen Asian Income.
She believes companies in Asia are less likely to cut their dividends in the near future, helped by the fact that the region has striven in recent years to develop ‘a dividend culture’. She adds: ‘Asia is home to many cash-generative businesses that are strong financially.
‘This gives confidence that they can withstand any deterioration in the region’s economic outlook. The pandemic has highlighted the importance for investors of having a well diversified portfolio of income stocks.’
Juliet Schooling Latter likes investment fund Fidelity Global – which provides an income of 4.5 per cent – and Schroder Asian Income, yielding 4 per cent.
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