Low dividends under the microscope

The recent barrage of high-profile dividend cuts and passes has dealt yet another blow to investor confidence and placed a cornerstone of British investment culture on shaky ground.

Amid a backdrop of depreciating asset values and near-zero deposit rates, income has become increasingly important to investors, but so far the signs are this recession will be unlike any of those since the 1970s.

This time, instead of dividends continuing – and even growing – as company earnings deteriorate, dividends could fall by as much as 30 per cent, according to some income fund managers.

Threadneedle's Chris White, manager of five UK growth and income funds, including UK Overseas Earnings and Pan-European Equity Dividend funds, believes the FTSE All-Share's bias towards the banking and financial services sectors is responsible for making this period more painful for investors reliant on dividend income than in the past.

“The past year, compared with 2008, will have experienced a substantial reduction in income from dividends of up to 30 per cent - much bigger than in 1991 and other recessions,” he says.

According to Abbey Shasore, director of specialist researchers and forecasters Dividend Analysis, the first 10 weeks of this year already show what may become a downward trend for UK dividend payments.

The number of FTSE 100 companies scrapping their dividends has leapt from 13 during 2008 to 48 since the start of 2009. So far this year, 33 FTSE 100 firms have reduced their dividend payments, compared with 50 companies during the whole of 2008.

“The banking and finance sectors will be hardest hit, and most dividend cuts are coming from within the FTSE 100," Mr Shasore says. “But we are seeing an upwards trend in the number of companies passing dividends or decreasing payments coming from outside of the top 100 companies, involving more medium-sized companies too.”

According to Mr White, 60 per cent of the dividend income market is derived from the top 10 largest stocks, although the business model and sector are also integral to how resilient a company’s dividend payments will be.

While it is too early for Dividend Analysis to predict accurately when the inflection point in dividend reductions will occur, it will provide cold comfort to investors today.

Managers of funds within the IMA UK Equity & Income sector are mulling over whether to follow this trend and reduce their own income targets, or maintain - and in some cases, as with F&C’s High Income fund, increase - their income targets.

Chris Childs, manager of the F&C fund, revealed the decision to increase its target income level from 2 per cent above base rate to 5 per cent – by using a derivatives-based overlay strategy – was made to ensure the fund remained competitive and to benefit its investors, the majority of which use it as if “an alternative to an annuity”.