Laura Foll, UK equity income portfolio manager, highlights the role of diversification in an investment environment of continuing uncertainty.

In recent weeks many companies in the UK have suspended their dividends. This trend has so far been predominantly (although not exclusively), in those sectors that are directly impacted by the COVID-19 coronavirus. This includes retailers such as Marks & Spencer and Shoezone, and those in the travel & leisure industry such as pub operator Marston’s. Elsewhere, there have been dividend suspensions from cyclical companies that are more sensitive to changes in the economy - which were already highly indebted, such as chemicals business Elementis. All of these companies are seeking to preserve cash in the face of uncertainty with regards to how long the demand weakness and business disruption will last. Dividend suspensions have generally been well received by investors as they are seen as the right decision for the long-term viability of the business. We expect to see more companies reach the same decision and suspend dividends in the upcoming weeks. Aside from the impact of the virus there are also questions rightly being asked about the ability of oil & gas companies to continue to pay their dividends given the current lower oil price.

This environment presents challenges for us as income investors. We are aware that investors look to us to both grow income and capital over time. While maintaining similar levels of dividends will be difficult in this environment, the most significant advantage that we have as active investors versus the broader UK market (the FTSE All-Share Index) is diversification.

pie chart diversification

Credit: Getty Images.

Currently the dividend yield estimate on the FTSE All-Share Index for 2020 is optically 6.9%*, but it will likely prove illusory. 11% of the FTSE All-Share Index’s dividend income last year came from one company, Royal Dutch Shell, while a further 8% came from HSBC, and 6% from BP. The top ten income payers in the FTSE All-Share last year paid 48% of all dividends**. For the portfolios that we manage, the equivalent number has been materially lower because we aim to more evenly spread out the income generation across a larger number of companies. Not only is the income more widely distributed but we deliberately choose companies that have different end markets. GlaxoSmithKline does not have the same earnings drivers as Direct Line, which does not have the same earnings drivers as Severn Trent, HSBC etc. Some of the small companies held may also surprise the market with their ability to maintain dividends – quite often management teams are the same ones that managed the business during the Global Financial Crisis and have learnt lessons on building sufficient dividend cover and maintaining balance sheet strength. In a year in which dividend reductions and suspensions will likely be widespread, diversification will likely prove the best approach for those seeking income.

 

Dividends may vary and are not guaranteed. Past performance is not a guide to future performance.

*Source: Bloomberg as at 23 March 2020. Dividend yield estimate refers to 2020 annual dividend yield for the FTSE All-Share Index (31 December 2020). Dividend estimates may vary and are not guaranteed.

 ** Source: Lazarus Economics as at 31 December 2019.

 

Glossary:

Dividend yield: the income received on a stock relative to its price, expressed as a percentage.

Dividend cover: the ratio of a company’s income to its dividend payment. The measure provides an indication of the sustainability of a company’s dividends.

Balance sheet: a financial statement that summarises a company's assets, liabilities and shareholders' equity at a particular point in time.