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The spectre of dividend cuts is again looming large over equity income funds - and this time the reality may prove more painful than in the past.
Payouts are beginning to be cut the world over in light of the coronavirus crisis. In the UK, mega-cap stocks like the oil majors are a particular cause for concern, given the share of payouts for which they account.
Speculation of mass dividend cuts among large UK corporates has been around for years, but a real crunch point appears imminent. Nine of the top 15 dividend payers in the UK market - which between them accounted for two-thirds of payouts in the final quarter of last year - now sit on dividend yields of nine per cent or more.
It’s the smaller payers who have been first to cut - and unusually, as the FT notes, they haven’t been punished too badly by investors for doing so.
Does the clear the way for more large caps to follow suit? Not necessarily: Lex thinks Shell and BP should be able to confound the doubters again and maintain payouts this year.
For fund selectors holding UK equity income funds, it’s dividend growth that matters as much as absolute payouts. That’s certainly now off the agenda for 2020.
While there are exceptions, like funds run by Chelverton and Unicorn, selectors tend to favour whole-of-market UK equity income strategies. These favourites, as judged by our fund selection database, hold an average of 30 per cent of their portfolios in the top 15 dividend payers, according to our analysis. But if there is a macro factor bearing down on UK income funds right now, it’s style not size.
UK small and mid caps have suffered more than larger companies during the sell-off, and the income strategies that have done best during the downturn - like, say, Trojan Income - don’t shy away from holding the bigger payers. But portfolios like Trojan Income are more of a blend of value and growth than most UK income funds, which have tended to be attracted to the higher yields on offer from value shares. That, as much as the risk of lower payouts in future, has been what’s hurt the chasing pack.
Value shares aside, there are other reasons to think large caps might continue to work relatively well in the weeks ahead. HSBC analysts note the 40 most liquid stocks globally have outperformed significantly since the end of February. That arguably stands in contrast to the bond market, where liquid positions have suffered as a result of investors’ demand to raise cash. In equities, the analysts say, extra liquidity is giving investors the option to adapt portfolios, now or in future, “without significant trading costs”.
Those of a buy-and-hold inclination, even in times like these, will have little truck with that argument. But they’ll acknowledge that there is one area in particular where large caps remain dominant.
We remarked the other week that the tech giants - many for obvious reasons - have continued to outperform all-comers during the downturn. That remains the case today, and it has unsurprisingly had a knock-on effect for tech-focused funds themselves. A handful are down less than 10 per cent over the past month, and a tendency to focus on a handful of big winners means the vast majority are ahead of tech indices, too.
That kind of outperformance is harder to come by in US equities as a whole. Managers do have more capacity to overweight individual shares here, given their index weightings in the likes of the S&P 500 are lower than in tech-focused benchmarks. But most have understandably spread their investments further afield than just one sector - and that has come at a cost to relative performance.
Still, position concentration can matter more than sector preferences. Loomis Sayles’ US Equity Leaders fund - the best performing US equity portfolio during the sell-off - is only marginally overweight the technology sector, but has packed its top ten with such names. That’s served it well at a time when earnings visibility is close to zero for many other parts of the market.
The FCA’s decision not to ban short-selling, in contrast to some peers around the world, saves wealth managers from having one more fund selection problem to deal with.
It’s a move that makes sense: if nothing else, the evidence of recent weeks is that few hedge funds have been able to capitalise on the recent volatility.
That same finding applies to Ucits long/short managers, many of whom have been similarly whipsawed by markets. One who has prospered after a long spell on the sidelines - Argonaut’s Barry Norris - thinks the ability to generate short alpha “has become a lost art in a bull market”. At this rate, it’s a skill with which many absolute return managers will need to quickly refamiliarise themselves.