Ben Lofthouse, Fund Manager of Henderson International Income Trust, provides an update on some of the dividend trends that his team are seeing within the world of equity income and what they are doing to react to the COVID-19 pandemic.
The changes to social and working practices because of COVID-19 have benefited many companies, notably the technology, pharmaceutical, utilities and telecommunication sectors and the dividends they pay.
Economically-sensitive areas of the market, such as leisure and airlines, have been most impacted, along with oil and gas companies because of the slowdown, while regulators and central banks in some parts of the world have asked the banking sector to put a hold on paying dividends.
The uncertainty has left large parts of the market looking attractively valued from a historical perspective and a selective approach should allow for investment in leading companies that are able to fund their dividends while investing for the future.
Firstly, I will address what we are seeing in the companies that we own in terms of how they are dealing with the current crisis. Overall, I would say that company results from the six months after COVID-19 started are better than we would have expected.
We have seen a lot of companies move very well to home-working environments and an increase in technological innovation across all industries. This has been good for areas like the technology sector, which we have invested in more and more over the last few years. areas like pharmaceuticals have benefited along with utilities and telecommunications because the day-to-day items we use in life have continued to operate even with large parts of the workforce working remotely.
Key sectors impacted
There are key sectors that are being significantly impacted, areas like leisure, notably airlines and tourism, and areas within the financial sector. While the financial sector has been impacted, the bank loan impairments – where the principal loan amount and further interest payments are unlikely to be collected by the bank – have not been as bad as was expected earlier this year.
There are some very hard-hit parts of the market. However, the very large fiscal – government – and monetary – central bank – stimulus that has been applied to the economy and businesses has helped a lot of companies to stabilise their funding. Companies with financially strong balance sheets, like the kind of companies we seek to invest in, generally have come through this crisis well.
It is worth highlighting that a lot of companies have continued to pay dividends through this year. When COVID-19 first started to impact society and in turn markets, some regions – particularly the UK and Europe – experienced a large number of dividend cuts.
We have seen dividend trends in Asia, the US and Canada being much more stable the longer this crisis has gone on. We have not seen a spread of those dividend cuts to other areas. That has allowed us to pivot our portfolios to where the regulations and dividends have remained more positive.
As mentioned above, cyclical areas of the market that are highly sensitive to changes in the economy, like leisure and airlines have been most impacted, which are not sectors that we have had a great deal of exposure to. We reduced investment in the first quarter of 2020 where we did have holdings. Oil and gas companies have also been negatively impacted because of the slowdown in the economy but this is an example of another area of the market that we have been reducing exposure to over the last few years within our portfolios. Active managers, like ourselves, who can select opportunities have had the potential to maintain a much better level of dividend income this year than the overall market.
There is definitely a feeling that the worst is behind us. That is partially because a number of those companies that had high payout ratios – the proportion of earnings a company pays shareholders in the form of dividends – or had balance sheets that perhaps were vulnerable have rebased their dividends already.
The consensus forecast is for around a five percent dividend increase next year. The big variable between that figure being nearer 10 percent or less than five percent is likely to be whether the banking sector can pay dividends. The regulators and central banks in some parts of the world – such as the Australian Prudential Regulation Authority, the US Federal Reserve, the European Central Bank and the Bank of England’s Prudential Regulation Authority – have asked the banking sector to hold off on paying dividends. For now, the actual loan impairments coming through are less than many commentators, and the banks, would have thought five or six months ago. But it remains to be seen whether they will be given permission to pay dividends next year. At the same time, some European insurance companies have paid their dividend. Therefore, the extent of any dividend growth or payments next year will in some cases depend on external factors rather than boardroom decisions.
Opportunities for investors
We continue to see a lot of opportunities and in a lot of different sectors. There has been enormous divergence between what people discuss as value (undervalued companies) and growth (companies and areas of the market that have strong potential for growth). The uncertainty has caused people to look for defensive areas, which are not heavily impacted by the economic cycle, in all types of different assets. As a result, this has left large parts of the market looking very attractively valued.
We have not found it necessary to take a particularly strong view on the economic cycle. We believe we have got a very well-balanced portfolio, including areas like utilities where companies have continued to pay dividends. They have not been interfered with by governments and many of them might benefit from the increasing financial stimulus that is being directed towards carbon transition and green energy.
Many pharmaceutical companies have continued to pay dividends, with the crisis shining a spotlight on some of the expertise they have in areas like diagnostics. Again, that is quite an interesting sector – they are very diversified. Other sectors that have continued to cope quite well with the crisis include consumer staples and telecommunications. The progress on vaccines for COVID-19 has been faster than people would have expected, and the treatments are getting better.
While we are in the midst of a pick-up in the virus, I think on a 12 to 18-months view there will be a lot of opportunities in areas of the market that are not necessarily structurally challenged (from a significant change in the way a market or industry operates) but are currently cyclically challenged and sensitive to the current state of the economy.
Investing for the future
Due to the ongoing virus situation it just might take a little bit more time for investors to feel less cautious about the world and investing. To conclude, we have not really had to change our process significantly this year. We still operate on the basis of looking for well-invested companies, often leaders in their field that are able to fund their dividends while investing for the future. And I am pleased to say there are still lots of these companies around. Many of them trade at more attractive valuations than they did last year. We are using these very unfortunate circumstances to make sure that we are investing for the future in the portfolio.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
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The information in this article does not qualify as an investment recommendation.
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