- Investment Insight
- 5 minute read
Investment income and what Trustees should expect in terms of income payments given the cut in dividends by many companies in the UK and overseas.
Income investors have been amongst the worst hit by the market falls as a result of COVID-19. This is particularly relevant for charities as income generation is a significant component of their investment strategy.
As much as £33bn has been wiped off dividend payments in the UK, compared to £4.5bn that has been maintained by companies. Amongst those that maintained their dividend payments were the defensive utilities sector in the UK - National Grid (yield on payment of 3.5%), Pennon (2.9%), SSE (4.2%) and United Utilities (3.3%).
Although a third of companies in the FTSE 100 are yet to confirm their dividend guidance, we expect the majority of those companies to continue to pay their dividends similarly to, or higher than last year. Amongst those companies are AstraZeneca, GlaxoSmithKline, M&G, Reckitt Benckiser and Unilever. These companies have strong balance sheets and business franchises, have outperformed the market during the pandemic and are well placed to deliver to investors both a reliable income stream as well as the potential for capital growth.
Encouragingly, BAE Systems has recently reinstated their dividend as well as British Land and Rio Tinto increased its first half payment. BP however has just halved its dividend – it was one of the highest paying companies in the UK.
These cuts will undoubtedly have a lasting and in some cases permanent impact on income payments from portfolios. Banks and oil used to form a significant part of the All Share Index in the UK. Both of these sectors have now either cancelled or reduced dividend payments.
Charities that are not permanently endowed can access their capital to meet any income shortfalls. However, a lot of charities will not be able to do so due to their statutory requirements. In the latter case, we have been advising clients to reduce exposure to the income-threatened banking, leisure and oil and gas sectors and increase exposure to healthcare, basic materials, consumer goods and utilities.
The largest reductions in dividends have come from the UK equity market, which has under-performed other major developed markets. Some overseas banks, in particular in Europe, also cut their dividends, however in the US the cuts were significantly lower. This, combined with the large weighting to technology stocks has meant that the US market has been the best performer during the pandemic. The yield on the S&P 500, however is less than 2%. In capital growth terms, the S&P 500 has risen in excess of 45% since the March lows.
For those charities that adopt a total return investment strategy, it is important that a well-diversified portfolio of UK, US and other overseas equities as well as corporate and government bonds is in place, alongside suitable alternative investments and residual cash. This type of portfolio will enable a combination of income and capital to be consistently generated that should keep pace with inflation over the next few years.
Charities would have seen an increase in volatility in their portfolios so far this year as well as a fall in income of 20%-30%. Despite this, global equities, led by the US, have recovered and are trading close to their highs before the pandemic. The UK equity market, by way of comparison, is still down by c20% for the year to date.
Returns for Q2 2020, as reported by ARC, show positive returns of 9.5% for the Charity balanced benchmark and 11.8% for steady growth.
It may have been a difficult decision to move away from UK equities for many charity trustees who traditionally have valued the higher dividend yields of the UK equity market; however investing away from the UK has been beneficial from a total return prospective given the large weighting of banks and oil and gas stocks in the FTSE 100 where we have significant pressure on income. Property yields have also been depressed; however we have recently seen improved sentiment across the housebuilders. The biggest risk remains that of a second wave of the virus, which will lead to further volatility in the equity markets and potential falls in income. The commitment from central banks, however, to provide support to their economies for as long as it is required is providing strong support to the capital markets, as seen by the recent market recovery. A second lockdown will certainly prove testing; we do however believe that, on balance, the impact will be significantly less and that we have passed the most difficult period.
Please remember that investments can go down as well as up, and a charity could get back less than they originally invested.