Dividends: from hero to zero

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Six months ago, IHS data provider Markit predicted 10% UK dividend growth in 2020. This week, I received a note from a broker telling me that UK dividend payments Kingdom could fall 30% this year. Ouch.

The Prudential Regulation Authority (PRA) on Wednesday ordered UK banks to cancel this year’s dividend payment (and any planned share buybacks).

This means that the total reduction could be revised to around 45% or even 50%. To put it in context, during the 2008-2009 recession, the dividend cut in the UK was only 14%.

You should find all of this disturbing. Dividend controls of any kind rarely tell you anything good about the future trajectory of the stock markets. The UK has a long history of this: dividend controls of some sort were in place in the late 1950s, late 1960s and 1970s.

Look back and you will see that their introduction was generally a sell signal. Indeed, once introduced, they tend to last quite a long time – and if they last much more than a year, you will suddenly find that you do have a portfolio of super risky fixed income products rather than stocks. .

But you should also be worried, because one of the great advantages of the UK stock market (for those looking to create retirement income in particular) has long been its spectacular income-generating features. Last year, in a world where yields were generally low and nonexistent, the average yield in the United Kingdom was more than 4%.

There has been concern about the sustainability of this situation for ages – all of these dividends have not been comfortably covered and the murmur has long been over the risk inherent in the concentration of payments between a few sectors and stocks. Just five stocks last year generated more than 35% of UK dividend income.

We are of course not alone in our suffering. In Europe, if bank dividends fall to zero and other sectors experience the same decline as in 2008, total dividends will drop 42%, according to UBS.

The United States could do a little better. Distribution ratios have long been lower than in the UK, in part because US companies tend to use buyouts as a variable in addition to dividends. But even with that caveat, I think we all know that the U.S. numbers won’t exactly trigger a party.

Right now – for a few reasons to be happy. Yes, there are economic horrors to come. And yes, most of the profits for businesses here will be shocking. But shocking profits don’t make as many shocking dividends.

During the 2008 recession, the price of oil fell from about $ 140 to about $ 35. Dividends were still paid. Overall, according to UBS, dividends tend to fall at around 40% of the rate of pay. At the same time, controls over bank dividends may not be as important as controls are generally.

Yes, you should add the adoption of such socialist measures to your list of long-term risks. But since their announcement is a sell signal, the announcement of their end is a buy signal. This time, you got both at the same time (the checks are only valid for one year).

Confused as a signal? Yes. But is it the political virtue of the 1970s that signals hell? Not yet. It should also be noted that British banks have entered this crisis in top form: a year of cash conservation can only help them.

This may well be the case for some of the other dividend slashers. Many of the companies that cut their dividends today may not need them either and would not dare to do so in any other environment.

Coronavirus and your money

But now it’s different: lowering your payment could be seen as an advantage – doing your part by hanging on to money, keeping a job and getting out of the fight when the freeze is over.

Close Brothers has just canceled its interim dividend and said it was “in line with our aim to help the people and business of Britain”. Isn’t that nice? All companies taking this route will be stronger in 2021 than they would have been otherwise.

So with our long-term investor hats, we have to take a deep breath and look through this year. One way to do this is to look at some of the funds that can behave – in terms of income at least – as if this year did not exist.

The Association of Investment Companies publishes a list each year of its Dividend Heroes – those investment trusts that have raised their dividends each year for more than 20 years (the city of London is at the top with an unbroken 53-year record).

Trusts have a few special features that make this possible. First, unlike open-end funds, they do not have to pay all the income they earn from the companies in which they invest in the form of dividends. They therefore tend to keep one in an income reserve to let them know that the possibility of smoothing the payments is there for a rainy day (hello a rainy day!).

Second, if they run out of reserves (which is kind of nonsense anyway), they can pay their dividends on their capital. You may not like the idea of ​​your capital being returned to you as income, but that means that if it is income you seek after you get it – without having to sell stocks (it’s is what makes them such good investments in retirement freedom).

The good news is that they shouldn’t have to do the latter, analysts at Winterflood say: the median trust has 129% of the value of its last dividend held in reserve. Caledonia holds almost 900% and the Scottish Investment Trust 300%.

With that, plus the ability to pay capital, you have to wonder why one of the 21 heroes would give up their dividend (and their record) now? None of them did so in 2008.

Extend this thinking to the equity income sector of investment trusts 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 reduction is unusual, says Alan Brierley of Investec.

In 2008, 11 out of 14 trusts actually increased their dividends, and the only one that reduced (Finsbury Growth and Income) fell only 7% – despite the fact that earnings per share fell 17%.

For full disclosure, I am an independent non-executive director of three investment trusts (including one in the equity income industry).

The key here is the mindset: these trusts want to pay dividends, they can and they do. Obviously, the longer this goes on, the less certain will become certain. But you could argue that this is already reflected in the price – the stock prices of many UK investment trusts have fallen at their highest discount relative to the value of the underlying assets since the financial crisis.

So if you want to be sure that you can get the income you need while staying invested (while accepting that you can get some of your capital back as income), some of the heroes of the dividend are probably worth it. ‘be examined.

For additional diversification, do not favor the highest yield (too much risk). But consider taking a look at Alliance Trust, Witan and maybe Brunner (I have the first two in my own portfolio).

All of them have strong income reserves, are well diversified, and offer intermediate returns – a combination that can give you as much certainty about your income, if not your capital return, as you may be hoping for right now.

Merryn Somerset Webb is the editor of MoneyWeek. The views are personal. [email protected]. Twitter: @MerrynSW



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