Six months ago, data provider IHS Markit forecast 10% dividend growth in the UK in 2020. This week, I got a note from a broker telling me that UK dividend payouts could fall by 30% this year. Ouch.
By Wednesday, UK banks had been ordered by the Bank of England’s Prudential Regulation Authority (PRA) to cancel this year’s dividend payments (and any planned share buybacks). That means the total cut could be revised to about 45%, or even 50%. To put this in context, during the 2008-2009 recession, the decline in UK dividends was a mere 14%.
You should find all this worrying. Dividend controls of any kind rarely tell you anything good about the future path of stockmarkets. The UK has long experience with this: there were dividend controls of one sort or another in place in the late 1950s, the late 1960s and the 1970s.
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Look back and you will see that their introduction was generally a sell signal. That’s because, once introduced, they tend to last quite a long time – and if they last much longer than a year, you will suddenly find that you effectively have a portfolio of super risky fixed income products rather than one of equities.
But you should also worry because one of the great pluses of the UK equity market (for those looking to create retirement income in particular) has long been its spectacular income producing characteristics. Last year, in a world of mostly low and no yield, the average UK yield came in at over 4%.
There’s been worry about the sustainability of this for ages – not all those dividends were comfortably covered and there has long been muttering about the risk inherent in the concentration of the payouts among a few sectors and stocks. Just five stocks generated over 35% of UK dividend income last year.
We aren’t alone in our suffering, of course. In Europe, if bank dividends go to zero and other sectors see the same fall as they did in 2008, total dividends will fall by 42%, according to UBS.
The US might fare slightly better. Payout ratios have long been lower than in the UK, partly because US firms tend to use share buybacks as a variable element on top of dividends. But even with that caveat, I think we all know the US numbers won’t exactly start a party.
Reasons to be cheerful
Right – now for some reasons to be cheerful. Yes, there are economic horrors ahead. And yes, most corporate earnings numbers from here will be shocking. But shocking earnings don’t make for quite as shocking dividends.
In the 2008 recession, the oil price fell from about $140 to more like $35. Dividends were still paid. Overall, says UBS, dividends tend to fall at about 40% the rate of earnings. At the same time, controls put on bank dividends might not be as big a deal as controls usually are.
Yes, you should add the embracing of such measures to your list of long-term risks. But inasmuch as the announcement of them is a sell signal, the announcement of their end is a buy signal. This time round you got both at once (the controls are only for one year).
Confusing as a signal? Yes. But is it 1970s-style political virtue signalling hell? Not yet. Note too that UK banks came into this crisis in good shape: a year of cash preservation can only help.
That may well be the case for some of the other dividend slashers. Many of the firms that cut dividends now might not either 100% need to and would not dare do in any other environment.
But now it is different: cutting your payout could be seen as a positive – doing your bit by hanging on to cash, maintaining employment and coming out fighting when the freeze is over.
Close Brothers just cancelled its interim dividend and said it was “consistent with our purpose of helping the people and businesses of Britain”. Isn’t that nice? All the firms that take this route will be stronger in 2021 than they would have been otherwise.
You don’t need to give up your dividend income
So with our long-term investor hats on, we need to take a deep breath and look through this year. One way to do that is to look at some of the funds that can behave – in income terms at least – as if this year does not exist.
The Association of Investment Companies publishes a list every year of its “dividend heroes” – those investment trusts that have increased their dividends every year for more than 20 years (City of London is at the top with an unbroken 53-year record).
The trusts have a couple of special features that make this possible. First, unlike open-ended funds, they do not have to pay out all the income they get from the companies they invest in as dividends. So they tend to hold some back in a revenue reserve to allow them to know the ability to smooth payouts is there for a rainy day (hello rainy day!).
Second, if they run out of reserves (it’s a bit of an accounting nonsense anyway) they can pay their dividends out of their capital. You might not like the idea of having your capital paid back to you as income, but it does mean that if it is income you are after you will get it – without having to sell shares (this is what makes them such good pension freedom investments). The good news is that they shouldn’t need to do that, say the analysts at Winterflood: the median trust has 129% of the value of its last dividend held in reserve. Caledonia has close to 900%, and the Scottish Investment Trust 300%.
With that, plus the ability to pay out of capital, you have to ask why any of the 21 heroes would give up their dividend (and their record) now? None of them did in 2008.
Extend that thought to the investment trust equity income sector as a whole (not quite the same group of trusts – you can be a dividend hero without being an income trust) and you will find that dividend cutting is unusual, says Investec’s Alan Brierley.
In 2008, 11 out of 14 trusts actually increased their dividends and the only one that cut (Finsbury Growth and Income) cut by a mere 7% – despite the fact that the earnings per share fell by 17%.
For full disclosure, I am an independent non-executive director of three investment trusts (one of which is in the equity income sector).
The key here is the mindset: these trusts want to pay dividends, they can and they do. Obviously the longer all this goes on, the less certain one will become. But you could argue this is already reflected in the price – the share prices of many UK investment trusts have fallen to their steepest discount to underlying asset values since the financial crisis
So if you want to be sure you can get the income you need while staying invested (albeit accepting that you might get some of your capital back as income) some of the dividend heroes are probably worth looking at.
For extra diversification, don’t go for the highest yielding (too much risk). But do consider taking a look at Alliance Trust (LSE: ATST), Witan (LSE: WTAN) and perhaps Brunner (LSE: BUT) (I hold the first two in my own portfolio).
All have solid revenue reserves, are well diversified and offer middling yields – a combination that can give you as much certainty on your income, if not your capital returns, as you can possibly hope for right now.
• This article was first published in the Financial Times
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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