Pension funds and other income-focused investors hoping for another year of generous dividends in 2020 have instead been pummelled by savage cuts to company payouts.
A record $1.43tn was paid in dividends last year by companies worldwide, according to Janus Henderson, the asset manager. It had forecast that global dividend payments would rise by about 4 per cent this year. But then coronavirus struck.
Strict lockdown measures ordered by governments to limit the spread of the virus have created severe cash flow problems for companies across multiple sectors, forcing them to make painful cuts in payments to shareholders. In some industries, such as banking, regulators have stepped in to limit payouts.
The cuts have led to widespread losses for dividend-focused funds, which are used by retirement savers for pension payments.
Analysis by the data provider Morningstar of 254 global, European and UK equity income strategies with more than $50m in assets each, shows that all of these funds have registered losses this year. Most, however, have rebounded strongly from their lows in late March on hopes that economies will recover rapidly as lockdown measures are eased.
Investors and fund managers are scrambling to assess the outlook for equity dividends that have become critically important to long-term investors because of the significant decline in bond yields over the past decade.
Dividends paid by European companies could fall 30 per cent this year and 15 per cent in the US, according to Thomas Schuessler, manager of the €18bn DWS Top Dividend fund, the largest global equity income product sold in Europe.
It has lost 10 per cent this year, recovering from its late March low when it was down by about a quarter.
Mr Schuessler says it is “not surprising” that some companies find themselves unable to pay dividends when coronavirus has paralysed entire economies, but he is confident of a healthy recovery.
“Dividends will come back with earnings when the economy recovers,” he adds.
UBS, however, is warning that less cash could be available for dividends in the future because companies may choose to emphasise building more resilience to disruptions into their businesses. Regulators may also put more pressure on banks to support economic activity in preference to paying shareholders, while governments may decide to raise corporate taxes to help pay for the huge bills resulting from coronavirus.
“Reinstating shareholder distributions may not be straightforward,” says Victoria Kalb, a sustainability analyst at UBS.
Dividends have been the main driver of total returns in stock markets outside the US over the past five years.
“Without dividends, investors would have made very little, if anything at all. To now see dividends under extreme pressure is a concern, if those dividends are not reinstated or take several years to rebound,” says Andrew Lapthorne, a quantitative strategist at Société Générale.
Just five sectors — banks, energy, pharmaceuticals, insurers and capital goods — are responsible for more than half of the total dividends paid in Europe.
Banks have largely halted payouts on the instruction of regulators while energy companies’ cash flows have shrunk due to low oil prices. Royal Dutch Shell cut its dividend last month for the first time since the second world war and its rival BP has said that distributions to shareholders will be reviewed before the end of June. BP’s shares yield 10.5 per cent, which is seen as unsustainably high by many analysts.
Dividend cuts and suspensions by banks, oil companies and insurers have had a particularly large impact in the UK where FTSE 100 companies have already reduced payouts to shareholders by nearly £24bn, according to AJ Bell, the broker.
Mark Peden, lead manager of the $416m Kames Global Equity Income Strategy, warns that some service sector companies may be permanently impaired by the health crisis but other businesses will want to demonstrate that they remain attractive to shareholders.
“Companies will be keen to reinstate dividend payments to prove that they too are becoming healthier,” says Mr Peden.
Dividend cuts are also mounting in the US where at least 67 constituents of the Russell 1000 index have already suspended payouts, more than during the financial crisis, according to Morgan Stanley. A further 36 constituents of the Russell 1000 index have reduced dividend payments but more than 200 US companies have also announced that they will raise dividends this year.
“Most of those increases were announced before the US equity market peaked in February and are potentially at risk for cuts down the road,” says Boris Lerner, an analyst at Morgan Stanley.
In addition, companies that seek assistance from the US government or that use the emergency lending facilities offered by the Federal Reserve will face restrictions on payouts to shareholders.
Returns for investors in the US stock market over the past five years have been driven mainly by earnings growth and rising valuations with dividends playing a less important role.
But cuts in company payouts present a clear threat to dividend-focused exchange traded funds. These index trackers have become the largest dividend funds and are very popular vehicles for investors looking for inexpensive access to reliable equity income streams.
Investors ploughed $12.9bn into dividend ETFs last year, helping push assets across the sector to $162bn at the end of December, according to ETFGI, a London-based consultancy.
Dividend ETFs come in two main flavours: providing exposure to companies that deliver a high yield or to companies that consistently increase payouts. The latter are known as “dividend aristocrats” and are the focus of the two largest dividend ETFs.
Vanguard’s $40.2bn dividend appreciation ETF, known as VIG, has sunk 11 per cent this year, while State Street Global Advisors’ $14.2bn dividend ETF, known as SDY, has dropped 22.8 per cent.
Investors have pulled $1.2bn from SDY this year but VIG has gathered inflows of $3.4bn.
Other dividend ETFs track companies that deliver a high yield compared with the rest of the market. The largest of these, BlackRock’s $12.2bn iShares select dividend DVY, has fallen about 27.4 per cent this year and registered net outflows of $1.4bn.
Ryan Reardon, a senior strategist at SSgA, says the stock market turmoil triggered by coronavirus has not damaged the long-term attractions of dividend ETFs.
“Most investors in dividend ETFs are looking for them to deliver over the medium and longer term. The performance of dividend ETFs in these highly volatile market conditions is not a fair representation of the underlying fundamentals of these funds,” says Mr Reardon.
London’s stock exchange is home to 21 investment companies that have increased dividend payments over 20 years or more. Four of these “dividend heroes” have raised their dividends consistently for more than half a century.
The £1.5bn City of London Investment Trust and the £1.2bn Bankers Investment Trust, which are both run by Janus Henderson, boast 53 years of consecutive rises along with Dundee-based Alliance Trust. The £1.8bn Caledonia Investments trust has achieved 52 consecutive annual payout rises.
Investment trusts, which are structured as closed-end funds, can save up to 15 per cent of their annual income each year to build up a reserve that enables them to continue to deliver a reliable income in market downturns.
The coronavirus pandemic is the biggest challenge faced by these trusts but almost all of the 21 have built up revenue reserves equivalent to at least one year of future payouts, according to the Association of Investment Companies.
The main exception is Baillie Gifford’s highly successful £10.9bn Scottish Mortgage Investment Trust, which is focused on technology and growth stocks. The trust has reserves equivalent to six months of future payouts but it also has a dividend yield of just 0.4 per cent, a low hurdle to overcome.
The £189m Value and Income trust run by OLIM Investment Managers, which invests mainly in UK stocks and commercial property, has a relatively high 7.4 per cent dividend yield and a dividend reserve of just 0.7 years. It is trading at a hefty 31 per cent discount, suggesting its investors have already priced in more bad news on UK dividends.
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