What extraordinary times we are living in! Away from the heroes on the front line who are bravely battling this pandemic, fund managers around the world are spending their time trying to absorb and analyse the data, trying to second guess what the next stage of the pandemic will be, trying to establish whether we will see a V-shaped, U-shaped, or perhaps even a W-shaped recovery! An added challenge has befallen managers of income funds, with an unprecedented number of companies battening down the hatches, preserving cash while we navigate this period of huge uncertainty, resulting in dividend cut after dividend cut after dividend cut.
Since the start of the crisis, according to the Link Group UK dividend monitor, by 5 April, a record high of 45% of UK companies had cut their dividend. The Link Group predict a worst-case scenario for 2020 dividend payments at half the level of 2019. If, as we assume, this is a short-term phenomenon, then 2021 should see significant growth in dividend payments compared to 2020. I do, however, believe that we will also see a rebasing of many dividends to a lower level, meaning we probably won’t get back to 2019 levels of dividend payments for a number of years. This is partly because, in recent times, many companies have been reducing their dividend cover to increase the payouts to unsustainable levels and, indeed, coming out of this crisis I expect management teams to act more conservatively with lower leverage and lower payout ratios.
Let’s look at two of the largest sectors for dividends: oil and financial. The oil sector dividend payments will clearly be determined by how the oil price reacts in the coming months and years, alongside a reassessment of their cost base and how much they look to pivot towards more environmentally friendly energy sources. For the financial sector, and in particular the large UK high-street banks who have been pressured into not paying dividends by the regulator, future payouts will undoubtedly be influenced by the losses they may, or may not, suffer from the lending they are being asked to offer as part of the government bailout packages. If the regulation we have seen since the global financial crisis has resulted in the capital ratios being sufficient to weather the storm, they could quite swiftly return to being large dividend payers; if not, we could see another decade of them trying to rebuild their balance sheets and even more regulation.
Considering all of the above, one might ask why not simply change our portfolio to sell out of those companies that have cancelled their dividends and reinvest into companies that are continuing to pay – for example, selling out of the travel and leisure sector to invest in pharmaceutical companies. Undoubtedly, there will be a need for some portfolio reshaping, but shifting entirely into the companies that are still paying would result in significant sector concentration and most likely a very defensive portfolio that would not benefit from any future market rebound that may occur. The UK stock market is full of world-class companies and adopting this approach would result in a portfolio that has to ignore many of them. During times of crisis, I believe it is important for fund managers to stay disciplined to their investment process, try to look through the noise and continue to seek out the long-term winners.
In the JPM UK Equity Income fund we adopt an unconstrained but disciplined approach to stock picking. Through analysing cashflow metrics, returns on capital and earnings revisions, we seek to build a portfolio with a combination of high-earnings-growth companies paying little or no dividend, alongside steady compounders and more mature high-yielding companies. This melting pot of companies provides investors with an attractive dividend yield, combined with the potential for strong capital appreciation.
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