What lessons should we learn from cuts to dividends?

15 May 2020 | Markets and Economy


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Commentary by  David Hsu, senior investment product manager


Dividends have always been an important part of the total return a shareholder receives on their investment, but given the low-to-no growth environment of the past decade, payouts have become an increasingly significant factor in determining share prices.

As dividends and buybacks are being cut and withdrawn, what might be the lessons for equity investors, particularly those seeking income?

In the UK, combined annual dividend payouts grew at an average of 7.3% between 2010 and 2019, a cumulative increase from £54.6bn to £110.5bn1. This has carried share price growth with it despite challenging economic conditions, providing income-seekers with a rising natural yield from their portfolios as well as growing the capital value of their investments.

That positive trend has changed radically with the coronavirus crisis and dividends are facing a significant headwind. Almost half of UK companies had cut or suspended payouts by early April2, with the most optimistic forecasts suggesting total UK payouts could fall 27% from 2019's total. According to financial data provider Link Group's latest UK Dividend Monitor, a worst-case scenario could see total UK dividends fall more than 50%, while more conservative estimates put expected losses to shareholders between 32-39% on last year's payouts.

Don't bank on it

The biggest loss in the UK is likely to come from the banking sector, the country's second-largest payer of dividends3. The industry collectively agreed to cancel dividend payments for the remainder of 2020, amounting to more than £13.5bn in lost income for shareholders. The Prudential Regulation Authority has welcomed the decision and requested any outstanding dividends from 2019 also be suspended4.

The largest-paying sector of the UK economy in recent years has been energy5. Oil companies form a significant chunk of that group and were already in the midst of a production battle between the world's largest exporters before the consequences of Covid-19 were truly felt. The industry's supply and demand dynamics have taken an unprecedented shock, which saw the price of a barrel dip into negative territory on 20 April.

The damage is starting to be passed on to shareholders. For the first time since World War II, British-Dutch group Shell announced at the end of April it would be cutting its first-quarter dividend to weather the impact of the Covid-19 crisis.

The industry is not under the same political pressure to withhold shareholder payouts, though, and UK-based BP maintained its dividend for the first quarter, despite seeing profits plunge by two-thirds during the period.

Global diversification

What does this mean for investors and what lessons can they learn to protect their portfolios in the future? In our view, one part of the answer is in a globally diversified portfolio, which is never more pertinent than during times of economic turmoil.

Income-seeking portfolios with a strong bias to the UK could be missing out on international income from regions where regulations and customs are different and payouts will be less affected. For example, financial companies in the US are not under any obligation to withhold dividends, while parts of Asia may be better equipped to maintain dividend payments.

The different regulatory and economic conditions are reflected in the total returns of regional equity indices between 1 January and 11 May 2020, where UK (-20.8%) and European stocks (-16%) suffered more than the US (-8.2%), Japan (-12.7%) and the broader Asian market (-9.2%).

In other words, the hit to a globally balanced portfolio may be cushioned and less sensitive to regional shocks.

Total 2020 return (%) to 11 May

Source: Factset, Vanguard.
Notes: Based on MSCI Gross Total return indices in local currency from 12/31/2019 to 11/05/2020; North America = MSCI North America; US = MSCI USA; Europe = MSCI Europe; Europe ex UK = MSCI Europe ex UK; UK = MSCI United Kingdom; Eurozone = MSCI European Economic and Monetary Union; Germany = MSCI Germany; Pacific ex Japan = MSCI Pacific ex Japan; Japan = MSCI Japan; Latin America = MSCI EM Latin America; EMEA = MSCI EM EMEA; Asia = MSCI EM Asia.


Income investing vs total return

The other part of the answer might be for income-seeking investors to consider the benefits of targeting total return, rather than natural yield from their investments. One of the main advantages of total return strategies is the broader universe of stocks to choose from when dividends are not the fundamental criteria.

A greater range of securities in a portfolio also helps dampen volatility by spreading risk. Income-driven strategies tend to display a significant bias towards value stocks6, which often means the portfolio is highly exposed to a handful of stocks that pay an attractive dividend. If those stocks cut or suspend their dividends, the portfolio suffers and the income may fall below an investor's spending requirements.

Another benefit of targeting total return is greater flexibility when it comes to withdrawals. By targeting total return and thereby growing the value of the portfolio at a faster rate, investors can supplement portfolio income with capital growth to fund withdrawals. This can come in handy when income from dividends falls below the required spending amount.

A key point to remember is that capital not paid out as dividends can be used to support the business during a crisis, as is the case with many companies now, or reinvested to increase the company's share price in the future. That may not be as relevant in the case of banks in the response to the Covid-19 pandemic, which are under some obligations to support the wider economy. Nevertheless, broadly speaking, a little patience and discipline can bring long-term rewards.

We suggest that investors remain diversified across their income-generating portfolios. They should also not deviate from their long-term investment objectives and remain patient for more certainty to emerge around earnings and dividends.


1,2,3,5 UK Dividend Monitor, Link Asset Services

Vanguard Research, An Evolution of Smart Beta and Other Rules-Based Active Strategies, 2015



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