Should you ditch your UK equity income funds?
Income investors have had a tough few months as growing numbers of UK companies have announced plans to cut or defer their dividends in response to the coronavirus outbreak.
Arguably the biggest blow came when Britain’s largest banks – stalwarts of many income portfolios –all agreed to scrap £8bn of dividends following pressure from the Bank of England to shore up balance sheets ahead of a likely recession.
Research from investment platform AJ Bell says £30bn of pay-outs have been axed in total so far this year, with more cuts expected after the government banned firms using its coronavirus loan scheme from paying out dividends to investors.
These cuts have already left some income investors with large holes in their portfolios, AJ Bell, the investment platform, says.
Half of investors questioned by the firm said dividend cuts have hit their portfolios and reduced the income they’re getting, by an average of 27%.
Some have been hit far harder, with 40% seeing dividend cuts of 30% or more and one in five investors saying they’ve seen their investment income cut by 50% or more.
“Those who rely on their investments to fund their lifestyle will now be faced with a really difficult choice, of selling some units of their investments to make up the shortfall – potentially at a loss considering current market conditions – or face a cut to their income, meaning they need to cut their outgoings,” says Laura Suter, personal finance analyst at AJ Bell.
Sell or stay invested?
Those who can afford to stay invested may be tempted to trim their UK equity income holdings in light of the negative news around dividends.
However, rash decisions made during times of panic rarely turn out well for anyone, investors included.
“Many companies are suspending their dividends for the right reasons,” says Rebecca O’Keeffe, head of investment at Interactive Investor, another platform.
“A cut in dividends has historically been perceived by the market as a problem, and indeed companies early on in this crisis were punished (sometimes severely) for being up-front and pro-active, but sentiment has shifted somewhat over the past few weeks and we are now seeing more sense and less panic.”
She adds: “Income can sometimes be a misnomer. It is the total return which an investor ultimately receives, and this is fundamentally what matters, so a temporary suspension or trimming of dividends may reduce ‘income’ in the short term, but it is not necessarily going to harm the long term returns from a share if it is the right thing for that company to do.”
Another point to consider is plenty of good UK businesses are still paying dividends.
Suter says: “There are still lots of companies that have pledged to maintain their dividends, including 26 FTSE 100 firms, with total dividends maintained standing at £12.3bn. This means there are still options out there for investors and fund managers alike.
“Part of the role of UK Equity Income managers is to spread their investments across a range of different dividend-paying companies, including across different industries.”
Then there are companies that will bounce back from the crisis. David Smith, who runs the Henderson High Income fund, says he remains supportive of a number of these firms, especially if the long-term fundamentals of the business continue to be strong.
“The majority of dividend suspensions have been from cyclical companies or those companies most impacted by government lockdowns. It’s important to maintain holdings in this area, albeit focusing on the best quality companies that can survive a downturn and emerge stronger versus its competitors,” he says.
He cites companies such as bus operator National Express, Premier Inn owner Whitbread, industrial Vesuvius and events company Informa as offering value for long term investors once economies and profits recover.
Time to take stock
However, there’s nothing wrong with using the crisis to take stock of your portfolio and make sure your sources of income are spread out across sectors and companies.
For many UK investors, UK equity income will form a core part of their investment portfolio – whether that’s through individual stocks or funds.
The current situation will likely highlight how exposed you are to UK equity income and whether or not you need to diversify your income stream.
Dzmitry Lipski, head of funds research at Interactive Investor, says: “Dividend diversification is key, and investors may well want to take a global approach to dividend income – and perhaps also sector and asset class diversification too.”
He suggests dividend paying investment trusts could offer a solution to income investors amid the dividend drought.
Unlike open-ended funds which are required to return all income generated to unitholders, investments trusts can retain up to 15% of the income they receive to create an income reserve which they can use to maintain dividend levels on rainy days to keep serving income shareholders through the good times and the bad.
Lipski says:“It is not raining but pouring from an investment standpoint at present amid the coronavirus pandemic, yet a number of investment trusts have remained resolute to meet their dividend objectives.
“Among these is Murray International Trust, which has resolved to pay an additional interim dividend, in lieu of the usual final dividend in light of the postponement of its AGM. The trust, a conservatively run globally diversified portfolio which targets capital uplift over the long term and above average dividend, has been able to increase its dividend each year for 15 years. It is currently the highest yielding investment trust in the global equity income sector, with a yield of around 5.6%.
“We also rate the City of London investment trust which has pledged to maintain its over 50-year track record of annual dividend growth. Shares in the trust, which principally invests in shares listed on the London Stock Exchange, have a robust yield of 5.7% and pay a quarterly dividend. Job Curtis has been managing the portfolio for 28 years, a length of tenure that is exceptionally rare.”