Covid-19 has obvious implications for companies’ cash flows and, consequently, their ability to return cash to shareholders (ie, pay a dividend).
This is not the first time since we launched the Threadneedle Global Equity Income strategy that we have seen a widespread reduction in dividend payments. Over the course of the global financial crisis (GFC), they dropped by circa 20%.
If a company’s cash flow is impaired, then paying dividends to shareholders simply cannot – and arguably should not – be sustained. The upshot is that management teams across the world are taking the difficult decision on whether to maintain, reduce or even suspend their regular dividend payments.
We have already seen the impact in the UK, where over 140 companies have announced cuts to their dividends1. In the US, the futures market is currently predicting a decline of over 25% in the value of dividends paid out by S&P 500 companies in 20202. The picture looks similar across the globe, although the response in Asia has been muted thus far.
The past month has even seen governments restricting bank and, more recently, insurance company dividends. Businesses that have taken support – for example, the use of taxpayer money to pay furloughed staff – are being pressured to suspend dividends and other forms of capital return.
Better to cut the dividend now and emerge well-placed on the other side, than risk the alternative.
What has been the impact on yields?
Our approach is to have a balanced exposure to different sources of yield to support a stable income profile across market cycles. We group the sources of income as compounders, cyclicals, secular growers and asset-backed names. This tends to remove any reliance on individual industries or regions to drive the yield.
In early 2020, we reduced our cyclical exposure adding more to what we refer to as compounders, stocks that have a steady growth profile and strong cash flow generation. This saw us add to positions in consumer staples and healthcare and reduce our exposure to energy companies – including the full exit of Occidental Petroleum whose dividend has dropped by 86% – well ahead of March’s oil price collapse.
We also trimmed our holdings in financials, a sector which has been subject to dividend restrictions.
So what does this mean for your income?
Having stress-tested each of our holdings for cash flow sustainability, balance sheet strength and available liquidity, we are comfortable with the current portfolio and its ability to deliver an attractive yield for our investors. As the strategy stands today, the 12- month forward yield is 4.6% compared to 2.8% for the MSCI ACWI3.
This figure will already account for revised estimates, but what if we were to exclude the bank and insurance dividends of all companies4, marking them down to zero? The forward yield would fall to 4.1%5. This assumes no repositioning of the portfolio but were we to reallocate capital away from those names at the wider market yield, it would drop to 4.3%6.
For a full version of this article, which also looks at the effect on stock selection and our ongoing focus, please click here.