2021 Grand National: Why horses for courses applies to the investment world
With a history dating back more than 180 years, the Grand National is undoubtedly one of the biggest...
It’s been a torrid year for dividends. The COVID pandemic and subsequent lockdowns have resulted in a deluge of cuts and suspensions, with Link Group estimating the total decline for 2020 being somewhere in the region of 45% in the UK – some £61 billion pounds less than last year^.
So it’s perhaps unsurprising that research from the Association of Investment Companies (AIC) shows that almost 90% of income investors’ portfolios have been impacted*.
In fact, nearly a fifth (17%*) of income investors have had to change their plans or lifestyle in response. Of those that have done so, 63% have cut back on non-essential items or activities, 39% have cancelled or changed holiday plans for financial reasons and 19% have pushed back retirement plans*.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies, said: “Although we are less than a year into the pandemic, dividend cuts have already had very real consequences. Our survey shows that the pandemic has affected almost every income investor, leaving many worried about whether their investment income will be enough to meet their future needs.
“But the research also revealed investors with investment companies are less concerned than others about a loss of income from their portfolios. A key reason for this is that investment companies can reserve some of their income to smooth their dividends over time, helping them achieve long track records of dividend growth.
The underlying income earned by the Schroder Income Growth investment trust fell by 16.3% in the 12 months to 31 August 2020, due to COVID-19’s impact on investee companies’ ability to pay dividends.
However, Bridget Guerin, chairman of the Schroder Income Growth Fund Limited, said: “At a time when interest rates and bond yields are so low, this is a good test of Schroder Income Growth’s raison d’etre. We want the manager and the portfolio to keep us in a position where we can maintain the record of increasing the dividend every year. With our revenue reserves equivalent to 11 months of dividends the board will be able to smooth out dividends should there be a future fall in investment income.”
Schroder Income Growth manager, Sue Noffke, commented: “We’ve started to see more clarity and poise about the liquidity situation of balance sheets and impact on businesses, so we’re unlikely to have another wave of cuts. Some companies are ready to continue to pay or reinstate payments that they passed earlier in the year. British Aerospace and Directline, for example.
“There has also been rumours that banks will be restarting their dividend payments, but this is obviously a political decision. I’m still cautious on this sector as we are yet to see the impact of COVID on their operations and all the talk of negative interest rates and further quantitative easing is a tough balancing act.
“For the calendar year 2021, the base case is for dividends to grow at 6% – I would hope this portfolio will do better.”
Link’s best-case scenario for the next 12 months is for UK plc to yield 3.6%, while the worst case is 3.3%^. A spokesperson commented: “The good news is that the worst is now behind us. Now that we have real visibility on what companies are doing, for 2021 we expect payouts to begin to bounce back, though a full recovery to pre-Covid-19 levels will take some years.”
Unlike investment trusts, open-ended funds are not allowed to keep income back for payment in future years. So there is no revenue reserve to fall back on. Nevertheless, a number of funds have experienced less-than-market falls, and most are confident that dividends will grow again next year.
Rathbone Income manager Carl Stick told us, “We have rebased our dividend down 20.5% – vastly better than the drop registered by the market. News on dividends this reporting season has surprised on the upside as far as we are concerned. And the reward investors, is a fund yielding over 4%, in an environment where income returns on cash are very low and the savings rate is very high. There is a lot of cash out there wanting income, and just not getting it.”
TB Evenlode Income manager Hugh Yarrow said: “The fund’s dividend stream is down around 25%. It is now yielding 2.9% vs a previous yield of 3.6%. It should be back up to around 3.3% by 2022. 70% of the portfolio is in ‘very’ or ‘quite low’ economically sensitive areas. We’ve added to existing holdings at much better prices.”
LF Gresham House UK Multi Cap Income manager Ken Wotton commented: “We focus on robust and resilient businesses with quality income streams across the market cap spectrum. In line with this, the fund has seen durable performance from portfolio companies and encouraging commitments to sustaining and reinstating dividend payments. We expect the yield on the fund to be c3.7% for 2020 and c 4.1% for 2021.”
The Montanaro UK Income team added, “2020 distributions are expected to be 50% lower than last year, but we estimate a 40% increase in 2021 with the fund yielding an estimated 3.1%. There may also be scope for some special dividends to be paid next year, which would boost this growth further. 31 companies [within the portfolio] have cut or postponed dividends … but 25 of these had net cash and/or more than 2x dividend cover. We are beginning to see companies resume payments including some that have announced specials to make up for skipped dividends and are expecting more reinstatements in coming months underpinning expectations of recovery in 2021.”
*Source: AIC/Research in Finance.
^Source: Link Group, UK Dividend Monitor Issue 43, Q3 2020