As the banks scrap their 2020 pay-outs, what's next for UK dividends?
Led by the banking sector, the overall UK market yield looks set to decline, yet it should still be attractive in relative terms and provide a very solid base upon which to build and grow over the coming years
We number an income-focused portfolio among our charges, here on The Value Perspective. So investors have naturally been asking us what could happen to the dividends they receive from the fund in the wake of the recent pandemic-induced collapse in share prices. Equally, it is only natural that we should already have been giving this matter some very serious thought.
Equity income investors should brace themselves for what could potentially be only the second market-wide dividend cut in UK history. The likelihood of this increased significantly last week when the Bank of England followed European regulators in calling for the suspension of capital distributions from UK banks in 2020. Bank boards will be able to revisit such distributions at the end of the year, the regulator added.
In a series of coordinated statements, Barclays, HSBC, Lloyds, RBS, Santander and Standard Chartered then announced they would cancel their dividends for 2019 and refrain from setting cash aside for investor pay-outs this year. The Bank of England also said it expected UK banks to refrain from paying cash bonuses to senior managers and signalled they should stop setting new money aside for bonuses for all other staff.
Shades of 2008/09
In these uncertain and highly volatile conditions, income-seeking investors will have greeted all this with further trepidation. As many will remember all too well, the UK’s only market-wide dividend cut to date came as part of the 2008/09 global financial crisis when financial stocks – which at the time comprised a fifth of the market’s total yield – all effectively cut dividends to zero overnight.
In any normal market environment, the negative effect of one sector coming under pressure would be offset by growth elsewhere and the market’s overall dividend would continue to move forward. But 2008/09 was anything but normal and, with no companies actually increasing their pay-outs, the fall in financials’ dividends was accompanied by a decline of some 25% across the wider market.
Clearly markets today are also far from normal – indeed, it is possible the decline in the overall UK dividend could be even larger this time around. Nevertheless, it is important to make the distinction between businesses that are not paying a dividend because they are unable to, and those that are able to but, in the current environment, ought not to do so.
This should help to add some context to why the Bank of England chose to take the action it did. With the UK’s banking regulator, along with the banks themselves, having learned the lessons of 2008, there is not a liquidity crisis this time – the steps announced last week were simply to ensure banks can provide maximum support for households and businesses through the economic shock caused by Covid-19.
The ‘S’ in ESG
While this support for the real economy effectively means the cancellation of final dividends for 2019 and no interim dividends or share buybacks in 2020, investors should not forget that any cash rolling-up within the businesses still belongs to shareholders. If it is lent prudently, shareholders will benefit from banks having stronger clients – and stronger relationships with those clients – as well as through enhanced profitability.
As we have discussed before in articles such as Why ESG matters in value investing, environmental, social and governance considerations are a fundamental and integrated part of our investment process, here on The Value Perspective – and, for the ‘S’ element of our analysis, we pay particular attention to how a company’s stakeholders are affected by its operations.
Since the onset of the Covid-19 crisis, the role of business in wider society and how it behaves towards stakeholders has really come under the market’s microscope, meaning companies’ treatment of their customers, employees and suppliers is under greater scrutiny than ever before. Indeed, ‘society’ is possibly the broadest catch-all term for stakeholders.
While the financial crisis severely damaged their reputations, today the banks are an essential part of the solution. This is an opportunity for them to rehabilitate those reputations and improve their stakeholder relationships. Last week’s actions highlight they are responsible corporate citizens and should now play a vital role in supporting society and the real economy through what will undoubtedly be a very difficult period.
A foundation for growth
With other businesses also likely to cut pay-outs as they prioritise short-term liquidity, we have already modelled for a significant dividend cut in our income-focused portfolio. Even if it is only an action the wider market is likely to replicate in due course, it is unfortunate. More positively, this environment now affords portfolio managers the chance to build a base upon which to grow their dividend very aggressively.
To use our portfolio as an example, the long-term compound growth of its dividend is about 6% a year. As a result of the lower base that resulted from the financial crisis, however, over the last decade that figure has been closer to 9%. Similarly, if there is a market-wide dividend cut, we are likely to reduce the fund’s distribution but this new base should again allow us to grow it significantly in excess of long-term history.
One final observation worth making is that, even if the UK market does end up cutting its overall pay-out, the starting dividend yield is sufficiently high that the income it generates will still put it among the most attractive income-based investments you can make. Cut the UK market dividend by 30%, for example, and it would still yield 4%, which is not far off the long-term average.
From an equity perspective, then, there will be few markets in the world that yield as much as the UK. Equally, when you compare the UK market to gilts or any other income-generating alternative, the dividend yields of both the FTSE 100 and the FTSE All-Share will still be relatively attractive in the context of global portfolios.
As such, while we do believe the overall market yield is set to decline, it should still be attractive in relative terms and provide a very solid base upon which to build and grow for the next three to five years.
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.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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