Dividends are an essential component of an equity investor’s total returns. In the UK for example over the ten years to the end of 2020 the FTSE 100 total return was 60%, of which 9.5% was generated by the change in price, with the balance coming from dividends.1 Dividend yields on equities are particularly attractive given the current climate of low interest rates and risk of rising inflation. However, as the pandemic proved, unexpected events can pose a significant risk to the global economy through their impact on company earnings, profits, and for income seekers – a company’s ability to pay dividends. A number of high-profile dividend paying companies cut their dividends during the pandemic. That being said, investors will be pleased to hear that globally, dividends were more resilient than expected, and that there was a clear benefit to having a diversified portfolio. In this article, we examine the impact of the pandemic on profits and dividends across different regions and sectors, and look at how the Henderson International Income Trust uses diversification to mitigate risks and provide investors with a stable income.

Essential to your returns

As an equity investor, the total return you receive comes from both capital appreciation and dividends paid. For those seeking income, dividends are attractive because they are regular, usually paid in cash, and as companies – in normal times – can quickly and easily pass on any rising costs to their business, they tend to keep up with or outpace inflation. This contrasts the income profile of cash and bonds which generally have fixed payouts - assets looking decidedly unfavourable given the current economic environment of low-interest rates and rising inflation. What is more, if you’re an investor who is happy to roll up their dividends and buy more shares (known as reinvesting), this puts a fire under your returns thanks to the power of compounding – a force the great Albert Einstein famously described as the “eighth wonder of the world”.

There is a problem, however, for those seeking dividends. With their distribution at the mercy of a company’s management team: dividends are not guaranteed and can be cut if a company faces financial difficulties. This could be due to company-specific factors (e.g., operational issues), broader issues such as macroeconomic or regulatory changes, or unexpected events such as the Covid-19.  Each will impact dividends differently across companies, sectors or regions, with last year a prime example.

A polarised impact

As visceral and gloomy as the pandemic likely felt for most of us, most companies survived, aided by strong fiscal and monetary responses from governments and central banks across the globe, and technological innovation that allowed them to adapt to the significant challenges that arose. Historically, dividends have tended to be less volatile than earnings and 2020 was no different in the end. While profits were impacted, many companies used their balance sheets to shield dividend cuts to investors: even though global profits received a haircut of 24% in 2020, dropping to £1.62 trillion in sterling terms, dividends fell by just 8%, to £906 billion.1 Behind the headline figures, however, the picture was extremely mixed.

Regionally, UK and European pay-outs fell sharply and the furthest, while dividends from the US, Canada, Japan, China and Hong Kong rose year-on-year. Why was there such a difference between regions? Amongst the factors driving this disparity were the severity of Covid breakouts and the extent of government-imposed lockdowns. These factors were particularly relevant in Europe and the UK – responsible for more than half of global dividend cuts in 2020 – with Covid running riot across the bloc. Although the pandemic wrought equal chaos in the US, less draconian lockdown measures resulted in a far lower impact for dividends. Meanwhile, countries in the Asia Pacific region reacted swiftly – containing the pandemic faster – meaning dividends in the region were more resilient compared to elsewhere in the world.

Regulators also impacted regional differences. In the UK, Europe, Australia, and Singapore, financial regulators forced banks to slash dividends to conserve cash, even though many were willing and able to pay. As a result, banks bore one-third of global dividend cuts. These harsh measures were not implemented by regulators in Canada or the US, which saw new dividend records being set in some areas, aided by companies choosing to curtail share buybacks ahead of dividends.

The divergence in performance was also evident across sectors. Dividends in the financials, consumer discretionary, retail & leisure, mining, energy and industrials sectors were heavily impacted. In contrast, classic defensives such as consumer basics, utilities, and healthcare increased their dividends. Technology companies also increased their dividends because of strong secular growth drivers and minimal interruption from the pandemic: many workers adapted to working from home, demand for services rose, and there is often no need for physical locations when selling and interacting with customers

Finally, differences in the sector make-up of regional markets played a part too in the profit story. For example, in the US, £1 in every £5 of pre-pandemic profits was earned by technology companies, compared to just £1 in every £16 across the rest of the world. In the UK, £1 in every £5 was earned by oil & gas, which declined strongly alongside dividends, compared to £1 in £14 in the rest of the world.

The pandemic demonstrated the endless complexities in seeking consistent and stable dividends. More importantly, however, it highlighted that diversification is extremely important – by sector, region, and company. While the UK market stock market is a significant contributor to the global dividend pot, it has drawbacks that can be solved by adding an international dimension to the income mix.

A decade of delivering rising income

The Henderson International Income Trust (HINT) provides UK income-seeking investors with a growing total annual dividend, as well as capital appreciation through a diversified portfolio of securities outside the UK. Since its inception (2011), HINT has successfully provided investors with a growing dividend every year, as highlighted in the chart below.2 Despite the volatility and disparity in global dividends over the past 18-months, the Trust’s dividend increased by 5% year on year.3 The Trust’s board has reaffirmed its commitment to paying attractive, progressive dividends going forward, and has recently increased the dividend by 20%.

In the event that dividends are not covered by underlying revenues, the board will utilise distributable reserves - a key feature of investment trusts - to ensure that investors achieve their investment goals. This should provide investors who rely on income received from their investments with confidence surrounding future distributions. This contrasts with open-ended funds, which have no option but to pass on the dividend reductions to investors.

Source: Henderson International Income Trust, as at 31 August 2021

HINT’s Portfolio Manager, Ben Lofthouse, also strongly believes that diversification is critical in smoothing out the impact of crises or different regional/sector dynamics on dividends, a point well made during the pandemic. For example, UK investors who took an international approach fared better than those focused entirely on the domestic market. As such, the Trust invests across three regions: Europe, Asia Pacific, and North America, to tap into a spread of dividends from around the globe. The flexibility to invest in these regions across different sectors provides Ben with access to the best opportunities globally. In addition, it enables him to take advantage of the short-to-medium trends in various markets/sectors whilst remaining positioned to benefit from innovation unfolding over the longer term.

As the Trust does not invest in the UK, this offers domestic investors with the opportunity to diversify their income stream with a complimentary profile that won’t overlap commonly held UK based investments. In addition, this scoots around the UK’s issue of dividend concentration risk, given the market is skewed towards a handful of large dividend-paying stocks.

Finally, Ben’s active management approach remains a crucial component in finding reliable sources of dividends. He can steer the Trust clear of yield traps – where companies with seemingly high yields turn out to be those with unsustainable dividends, which are then promptly cut. Furthermore, it also enables him to take advantage of the ever-changing market dynamics. Value and income strategies have lagged behind the ‘growthier’ segments of the market over the past decade, and the dividend news last year certainly did not help that. As a result, this disconnect has created enormous value discrepancies across the market, leaving plenty of opportunities for active managers such as Ben to take advantage of.

Encouraging road ahead

Global profits and dividends have bounced back strongly so far in 2021, and the road ahead looks encouraging as vaccines become more evenly distributed across the globe and nations return to health. During the third quarter of 2021, global dividends rose by 22% year-on-year on an underlying basis to reach $403.5 billion, an all-time high (for the third quarter). Globally, 90% of companies either raised their dividends or held them steady. For the year as a whole, dividends are expected to rise by 13.6% in 2021.4 Meanwhile, market expectations for earnings suggest an 18% jump to £1.91 trillion for 2021 and grow again in 2022 to a new record.5

The events of the last year have been a reminder that change is inevitable, and that different regions of the world, economies, business sectors, and companies can be impacted in different ways. Therefore, investing globally for dividends offers investors exposure to different sectors and trends they might not find in their home market, and more importantly, the benefit of diversification to their income in the event that things don’t go as planned.

Glossary

1 Source: Henderson International Income Trust, Global Dividend Cover Report 2021

2 Source: Henderson International Income Trust, Annual Report 2021

3 Source: Henderson International Income Trust, Annual Report 2021

4 Source: Janus Henderson Global Dividend Index, November Edition

5 Source: Henderson International Income Trust, Global Dividend Cover Report 2021