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Income Uncertainty

04/05/2020 … Author:

COVID-19 and the lockdowns around the world, which subsequently ensued have had a marked and meaningful impact on the global economy.  Whilst some countries have to date, suffered more than others, you would do well to find somewhere which has not seen some sort of negative impact.  With a weaker economy there typically comes weaker corporate earnings.  This then leads to a corresponding fall in share prices and whilst indices are above their March lows, many are still a long way from their February highs.

Earlier in this current malaise we heard the Financial Conduct Authority and Prudential Regulation Authority request that UK banks hold back from paying dividends.  Whilst the financial strength of these institutions has improved markedly and they are in a very different place to what they were in 2008/9, the authorities have recognised that they could have a very important role to play in the recovery and in supporting other businesses through this difficult time.  The banks have complied.  This request was then stretched to insurers, the authorities asking that they look to protect their financial strength by not paying dividends in case there are heavy claims for losses incurred from this crisis.  Whilst some have listened, others have dissented and either paid in full, or in part.

The pressure on dividend payments however has now extended to companies within other sectors of the market.  With companies in some sectors temporarily closed for business there comes a lack a revenue generation.  With a lack of revenue comes a lack of cashflow and with a lack of cashflow comes the inability to pay future dividends.  Just focussing on the UK in particular, we have so far seen 52% of FTSE 100, 74% of FTSE 250 and 56% of AIM 100 companies cancel their dividends.  Perhaps the most high profile was just last week where Royal Dutch Shell cut their dividend for the first time since World War II.  Whilst some dividend cutting may be more precautionary than anything else, it is occurring all the same. 

The cutting of dividends is not just isolated to the UK however and we have seen companies cutting dividends across the globe.  Many have cut for the same reasons as those in the UK but in some areas we have also seen that companies are unable to pay dividends as a condition of accepting government grants and loans in order to stay in business.  Other conditions typically included the ability to award bonuses and share option schemes.

Whilst within our portfolios we allocate to active fund managers who can make stock selection decisions we believe it is inevitable that we will see the distribution from equity income funds reduced.  This was confirmed when we spoke to Henry Dixon, manager of the Man GLG Income fund late last week when he confirmed that there will be a reduction in the fund’s next distribution.  We will also be speaking to Emma Mogford, manager of the BNY Mellon UK Equity Income fund later this week.  Whilst there are perhaps higher yielding opportunities in some stocks, the fund managers will always manage their portfolios with an open eye on the total return prospects and chasing too aggressive a yield at this time can be dangerous from a capital preservation perspective.

Whilst a reduction in income from such funds may be partly offset by higher yields available from investment grade and high yield bonds within multi-asset portfolios, given that government bond yields are at, or close to record lows unfortunately we would not be surprised to see a reduction in the income generated from Lowes model portfolios.  Hopefully, companies can return to the dividend register as soon as the outlook becomes a little clearer and active management can help through these times.  For example, Henry Dixon last week confirmed that 40% of the companies he currently invests in have net cash on their balance sheet, a strong figure indeed.  But for now, it is prudent to anticipate a reduced income.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested.

 

 

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