In the UK, more than half of FTSE 100 dividends are paid by just ten companies – and almost three-quarters of dividends come from the top twenty. This level of dividend concentration has always been a risk for UK income investors but, right now, it means finding an income amongst all the dividend cuts and cancellations is extremely challenging.
The large dividend payers have tended to be in sectors that are most stressed by the economic environment that has existed since the financial crisis. These sectors include oil & gas majors, which are suffering from the move to green energy, mining companies which have highly cyclical businesses - and large financials, which have the prospect of years of low-interest rates, and therefore lower profits.
Also, with many investors holding their shares for their above-average income, many companies have had to engage in financial engineering to support high and potentially unsustainable dividend payments.
This problem is particularly acute in the case of charities, many of which only draw their dividend income from the portfolio – without touching the growth element at all. The future of the charities’ good work may depend on the capital it owns proving enough income each year to fund their operations.
In these difficult times investors can be tempted to overstretch their risk budgets to target higher-income yields. This could mean investing in lower-quality credit in the bond market or investing in higher-risk regions.
Income investing now
Rather than allocating money to those areas which offer an attractive income, but which have stressed balance sheets and high levels of debt, a total return approach may be more appropriate.
By taking a total return approach we can target some of the high growth investment areas which are performing well – and are expected to continue to perform well throughout the pandemic. Rather than relying on dividends alone to provide an income, with a total return approach, we can pay out some of the growth in the investment as an income.
There are certain sectors which have performed well during the pandemic. This includes the healthcare, consumer staples and technology sectors. Companies directly involved in the Covid-19 response have naturally done well financially. These range from companies providing the NHS with personal protection equipment to healthcare companies who are involved in finding a vaccine. With people no longer able to dine out at restaurants, instead cooking at home, plus some panic buying as some prepare for the worst, supermarkets and online retailers have also done extremely well.
Also, companies that can demonstrate an ability to grow their earnings at an above-average rate – without an unwelcome degree of cyclicality – are attractive prospects right now.
When we initially build portfolios for clients, we agree on a long-term strategic asset allocation. However, it is crucial in uncertain times like this that we are flexible in our approach. The bespoke nature of our portfolios means that we can make tactical investment changes to take advantage of market opportunities.
More importantly, we can adapt to threats in the markets and we can also adapt to our clients changing needs. This is key in these volatile markets – and it helps to ensure that portfolios are not exposed to any unnecessary risks.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.