The ongoing collapse of corporate dividends is unprecedented and at the time of writing, FTSE 100 dividend futures are pricing a 62 per cent reduction in dividends this year.
This compares to a peak drop of 20 per cent globally in the Great Financial Crisis just over a decade ago.
Behind the collapse we have witnessed British banks, which constitute 13 per cent of dividends in the UK market, cancel their payments indefinitely.
Rightly they have been instructed to conserve cash in order to survive the economic fallout from COVID-19. Meanwhile BP and Shell, which together constitute 19 per cent of the UK market’s income, seem likely to cut their dividends unless oil prices recover sharply.
We saw dividends slashed by banks and oil producers during the Great Financial Crisis, but we did not simultaneously witness dramatic cuts across other sectors. In this crisis, we have already seen several retailers cancel their dividends in light of having no revenues.
Add to that restaurants, hotels, airlines, travel companies, manufacturers; the list is as wide as it is deep.
Even Real Estate Investment Trusts (REITs), which exist primarily to provide an income stream to investors, are suspending their dividends in the face of drastic reductions in the rents they are able to collect.
But the income needs of clients have not changed, presenting a particular dilemma for their advisers.
Whether they are individuals investing on their own account, or income fund managers serving the charities, universities, and savers of all descriptions who rely on dividends to finance their expenses, let’s start with what we think they should not do. There will be a great temptation for dividend investors to trade into high-yielding stocks to ‘plug the income gap’.
Wherever a company has withdrawn its dividend and there is a hole in the investor’s income stream, there will be an impulse to sell that company and reinvest the capital into another high-yielder, whether that be an oil company, a retailer, a tobacco company or a REIT, most of which now trade on high dividend yields.
But we think this is a mug’s game. Many of these seemingly high-yield dividends will prove to be a mirage.
In the current environment there is unprecedented uncertainty about which companies will pay their dividends and which will not. Selling a dividend-cutter to buy a company which subsequently reduces its dividend will simply incur trading costs. To take an example that has already played out, selling Hammerson and buying British Land in its place would not have ‘plugged the gap’, as British Land too has now postponed its dividend.
There is also a high risk that trying to plug the income gap will lead to a destruction of capital.
For many such companies we anticipate a permanent impairment of their dividend paying ability.