A fall in dividends this year is an inevitable side-effect of Covid-19

A clear and consistent investment approach is the portfolio equivalent of DNA and not even the recent market crash and ensuing dividend cuts should mean compromising that in the short-term pursuit of more income

07/07/2020

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

The market falls that followed the global spread of the Covid-19 pandemic ushered in a very difficult time for income-focused equity investors. As we revealed back in April, here on The Value Perspective, in What’s next for UK dividends?, with UK banks setting the pace for cutting pay-outs as businesses prioritised short-term liquidity, we had already modelled for a significant dividend cut in our income-focused portfolio.

Clearly we were not the only ones to be so concerned so early into the crisis and, just a few weeks later, the Investment Association issued new guidelines covering the UK Equity Income and Global Equity Income fund groupings as it looked “to ensure that, in light of Covid-19, they can continue to function effectively in the best interests of savers and investors”.

Due to the pandemic, the trade body noted, many companies had reviewed their dividends, with some suspending or postponing payments, which in turn had impacted on equity income funds. “This means some funds may be unable to meet the requirements to be included in these sectors, including two tests based on the annual and three-year rolling average yields of the FTSE All-Share and the MSCI World indices,” it added.

‘Short-term disruption’

Between them, the UK Equity Income and Global Equity Income sectors comprise almost 150 mutual funds that aim to provide a regular income for investors based on the dividend payments from the companies they are invested in. The new guidelines are designed to prevent any “short-term disruption” to these sectors, the Investment Association said, “so savers can continue to easily identify and compare equity income funds”.

“They will also enable fund managers to focus on long-term outcomes for savers, instead of potentially needing to make immediate changes to meet sector requirements,” it added. Or, to put it another way, the IA suspended its income criteria as it wanted to avoid a situation where fund managers fundamentally alter their approach, stretch for income and cause a spike in turnover – and thus a bubble in income-paying stocks.

Possible 50% reduction

As we observed in What’s next for UK dividends? and in What does the oil price drop mean for dividends? a month later, cuts to company pay-outs clearly do harm income in the short term and it will not be possible to maintain a flat income in 2020. Indeed, as the following chart indicates, some analysts are now anticipating a worst-case scenario of perhaps a 50% reduction in income from the UK market this year.

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Here on The Value Perspective, we are working hard to offset the worst of this – as evidenced by our buying bonds yielding close to 12% in Carnival Corporation, the world’s largest cruise operator, back at the start of April. Nevertheless, given the paucity of income presently within the market, it is not possible to make a significant difference without fundamentally changing the characteristics of our portfolio.

A clear and consistent investment approach does not just help investors understand what they are buying into, it is the portfolio equivalent of DNA – and therefore something about which any fund manager should be fiercely protective. As the Investment Association has recognised, no-one who seeks to generate income from equities should have to consider compromising their principles in the short-term pursuit of higher dividends.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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