Income investors face ‘dividend drought’ | Financial Times


Income investors were left reeling this week as UK-listed companies cut or cancelled more than £3.5bn worth of dividend payments to shore up their balance sheets against coronavirus disruption, the biggest drop since the 2008 financial crisis.

High street retailers, pubs groups, property companies, car dealerships, travel companies and UK housebuilders were among those seeking to conserve cash, with more than £1bn in cuts announced on Wednesday alone (see table below). 

Russ Mould, investment director at platform AJ Bell said the wave of cuts was “a big blow” for income investors, but warned that this was just the beginning. While it is too soon to predict an exact figure, AJ Bell and others estimate the final sum could reach £30bn, one-third of the FTSE 100’s projected dividend total for the year, based on four months of disruption. 

“The pace of cuts is picking up,” said Mr Mould. “More look inevitable as companies scramble to preserve cash and management teams accept their share prices are getting little or no support from any commitments to defend a dividend.”

In the UK, the dividend cuts have already exceeded the cuts seen in 2008, in the early stages of the global financial crisis.

In the US, members of the S&P 500 had been on track for a near 10 per cent increase in payouts this year before the coronavirus crisis hit, but instead of achieving new records their dividends are now likely to fall for the first time since 2009, when they dropped 21 per cent. 

In some cases, investors were “almost greeting the news of a cut with relief”, Mr Mould added, noting that shares in Kingfisher, the owner of B&Q, and travel group Go-Ahead both rebounded slightly after dividend cuts were announced.

“If a dividend cut is part of the near-term price that must be paid to ensure a firm’s long-term survival . . . then investors may well come to accept it, even if the loss of the precious payments is a big blow,” Mr Mould said. 

Cancelling dividend payments and share buyback schemes could also be important if companies have to approach the government for financial support in future, he added. 

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The scale of the cuts has also caused a knock-on effect for equity funds and investment trusts that are popular with income-seeking investors. 

Across the board, some of the most popular income funds have fallen by 30 per cent or more in the past month, according to Morningstar data.

Performance could come under further pressure if the scale of dividend cuts increases. 

“We have spoken to a number of UK equity income fund managers who are modelling short-term dividend cuts of between 15 and 30 per cent for their funds,” said Emma Wall, head of investment analysis at Hargreaves Lansdown.

“These professional investors are actually encouraging these cuts — taking the pain now can mean that companies are in a more robust state to weather the upcoming disruption and . . . quickly reinstate the dividend in the future.”

Meanwhile, investment trusts — closed-ended funds that are publicly traded — had fallen to average discounts of 22 per cent below the value of their underlying assets on March 19, the highest level since the financial crisis.

Property funds holding leisure, student accommodation and retail assets were hardest hit, but trusts focused on private equity and UK small-caps have also underperformed, with some losing half their value since the start of the year.

Trusts invested in blue-chip UK equities have held up better and are trading close to the market value of their assets.

Investment trusts are popular with income investors because of their reputation for high dividend payments. Some trusts, known as “dividend heroes” have increased their dividend every year for decades, holding large cash reserves to help them weather downturns where companies might struggle to increase dividends. Some hold as much as three years of dividend payments in reserve, according to data from the Association of Investment Companies. 

“Good quality equity income trusts focused on blue-chip UK equities actually have six, nine, or 12 months income set in reserve in order to maintain the current dividend, even while underlying companies cut their dividends,” said Ryan Hughes, head of active portfolios at AJ Bell.

However, if the cuts to the dividends of the companies held in the trust are big enough, some trusts could be wiped out of cash quickly. “Given the potential severity of the cuts that are coming, it’s going to be a challenge for them,” he said. 

Desperately seeking income

The dividend drought is expected to be prolonged, as the duration and extent of the virus’s impact on the business world remains unknown. It will particularly impact older investors and those drawing down an income from their pensions, who rely on income from their investments. 

“All investors will accept that the survival of a company must be absolutely paramount . . . but let us remember that there are many private investors, particularly the elderly retired, who are dependent on dividend income,” said Lord Lee, the investor and FT Money columnist.

However, advisers said that investors should prepare for the worst and adjust their income needs to no more that two-thirds of the dividends they expected to receive, to guard against depleting their funds at a time when markets remain volatile. 

As companies suspend share buybacks and are granted delays on filing their financial results, investors will find it more difficult to predict what might come next. 

Prudent income investors should hold cash reserves that are able to cover several months of expenses, advisers said, adding they should draw on these reserves now if necessary rather than selling off equities to meet their cash flow needs.

Charlotte Ransom, chief executive of challenger wealth manager Netwealth, said: “As long as you have enough cash for the next 6-12 months, you don’t have to cash out and crystallise losses just because the markets are down.” 

However, investors will have to look closely at their short-term income needs, and even consider taking a “vacation” from drawing down on their investments while the market finds its footing.