Global income in a lost decade for UK dividends

by Jennifer Hill
Key points:

Dividends in the UK are likely to be depressed for several years because of the economic disruption caused by coronavirus.

Investing in equity income investment trusts outside the UK exposes investors to currency risk, but is still a good way to diversify savings that have often been too reliant on a few big income stocks in the FTSE 100.

There are 4,500 dividend stocks in the world, just 250 in the UK.

Our experts highlight eight trusts offering access to range of sectors and regions around the world.

Bear markets for dividends are a rarity. There have only been six in the past 149 years compared to 16 for total stock market returns, according to an analysis by Schroders that uses the S&P 500 index in the US as a barometer.

However, they have historically lasted much longer – 4.8 years on average compared to 1.5 years. That makes sense: share prices react in advance of economic improvement whereas dividends pick up after companies’ financials improve.

How long will the current bear market for dividends last? Duncan Lamont, head of research and analytics at Schroders, says its speed and severity offers hope that it will be shorter than average.

‘Dividend cuts have been fast, comprehensive and relatively indiscriminate – this has not been a drawn-out episode,’ he said. ‘It could be more like the 2008-10 experience than those of more distant years.’

The global financial crisis triggered the first real dividend downturn since World War II. Dividends dropped 24% during a peak to trough that lasted 1.5 years from September 2008 to March 2010.

On top of this year’s cuts to dividends, futures contracts are pricing in further reductions in 2021. US dividends are priced to fall by more than 20% across 2020 and 2021. The subsequent recovery is projected to be slow – by around 3% a year on average. They are not priced to exceed 2019 levels again until 2030.

The picture is similar for other markets – or worse. FTSE 100 dividend futures are pricing in cuts of 47% from 2019 levels – a decline of 42% this year and another drop of 8% from a lower base next year – before a 14% rebound in 2022. Only minimal growth is expected between 2023 and 2026.

‘The UK looks worse, as does Europe,’ said Lamont. ‘UK dividend futures only stretch as far as 2026 and longer-dated ones are less liquid so some caution is needed when interpreting what’s priced into them. With that in mind, dividend futures are pricing UK dividends to still be almost 38% below 2019 levels in 2026.‘

Given how important BP and Shell are for UK dividends, the collapse in the oil price will have a lot to do with this. If the recovery in oil continues, dividend expectations are likely to move up as well.’

Dividend reset
An oil price recovery after its historic slump could lift dividend expectations

The UK is a highly concentrated market. Historically, half of FTSE 100 income has come from the ten largest stocks. Many are exposed to areas of the market that are cyclical, notably financials and energy. Banks have scrapped dividends after being asked to preserve capital to support the economy, while Royal Dutch Shell has cut its dividend for the first time since the second world war following the collapse in global oil demand. 

Charles Stanley analyst Adam Carruthers believes many British businesses have been paying too much in dividends rather than re-investing for the future – a ‘reversion to the mean’ for UK dividend payers may not happen. 

‘Many UK companies are facing a dividend reset, not a V-shaped bounce,’ he said. ‘Dividend investors can survive this unprecedented pandemic setback by adopting a long-term approach and actively picking the winning global companies of the future.’ 

Only 250 UK companies pay a dividend in an equity market of structurally challenged industries; globally, there are 4,500 dividend-payers spanning various countries and sectors.

Investing overseas involves some risk of a strong pound limiting returns

Of course, investing overseas introduces currency risk – fluctuations in the exchange rate affect the amount of income a UK investor receives – but the potential rewards are plentiful. Chief among them is diversification of underlying revenue streams from exposure to different geographies, industries and trends. 

‘Asia is exposed to huge structural themes like the rise of the middle classes and shift to product premiumisation,’ said Canaccord Genuity Wealth Management analyst Kamal Warraich. ‘Japan is a very different market with many managers focusing on population dynamics where healthcare and technology companies are transforming society.’ 

While dividend cultures are less embedded in other regions than the UK, some cultural nuances are beneficial. ‘Markets in Asia have fixed pay-out ratios, making it easier for investors to accurately predict future income,’ said Nick Craze, a stockbroker in the advisory investment team at Ravenscroft. 

Myriad investment trusts generate good and growing levels of income beyond the UK stock market – from global equity income strategies to regional and sector-specific trusts. Here are analysts’ and wealth managers’ eight top picks:

FundCalibre analyst Chris Salih likes Murray International (MYI), which boasts a 5.5% dividend yield – the highest among global and global equity income trusts – and distributes dividends quarterly. It has grown its dividend by an annual 3.4% over the past five years and has the most revenue reserves, equivalent to 1.1 times its last full-year dividend, according to Stifel. Long-running fund manager Bruce Stout (pictured) invests in equities and bonds globally. His highest allocation, at around 35%, is to Asia. ‘He looks for businesses that will deliver both growth and income and they tend to be domiciled in Asia and emerging markets,’ said Salih.

James Carthew, head of investment company research at QuotedData, favours North American Income Trust (NAIT), which yields 4% from predominantly S&P 500 constituents, paid quarterly. Francis Radano (pictured) and Ralph Bassett, experienced investors in Aberdeen Standard Investments’ North American equities team, balance defensive bellwethers, such as consumer staples and healthcare stocks, with cash-generative growth companies. They can top up the trust’s revenue account by writing options. ‘There are revenue reserves to draw on if needed but Radano says the trust’s income account is holding up well. He thinks companies in the US are more likely to suspend buybacks than cancel dividends,’ said Carthew.

Amid a ‘very challenging’ 2020, Peel Hunt is focusing on winning sectors – technology and healthcare. Anthony Leatham, its head of investment companies research, rates BB Healthcare (BBH) as offering the best of both worlds – access to the most exciting parts of the sector as well as a 2.8% yield, paid half yearly. ‘The normal way of accessing equity income from the healthcare sector would be to target the dividend-paying large-cap pharma names, but this is not where the exciting growth is,’ he said. Specialty pharma, managed care, biotechnology and diagnostics account for 70% of the portfolio, which is 94% invested in the US and managed by Paul Major (pictured) and Brett Darke of Bellevue Asset Management.

While Italy and Spain, and to a lesser extent France, have been hit hard by Covid-19, the industrial and financial giants of Germany and Switzerland have escaped relatively unscathed. IpsoFacto Investor director David Liddell likes JPMorgan European Income (JETI), which has more than 35% in these two countries. The trust, which is managed by a a team of JP Morgan fund managers led by Stephen Macklow-Smith (pictured) has a large slug in healthcare and consumer staples, where dividends should prove resilient. It also has significant weightings to Total and Allianz, which have held their dividends unlike Shell and most UK insurers. The shares yield 6.2%, paid quarterly. Even if dividends declined 25%, they would still yield a ‘rather attractive’ 4.65%, said Liddell.

For Carruthers at Charles Stanley, the best equity income managers sacrifice short-term yield in pursuit of better long-term income and capital growth. They avoid companies that are capital intensive, highly cyclical or over-distributing cash. He cites Richard Aston (pictured) of CC Japan Income & Growth (CCJI) among them. ‘This is a strong offering. It provides diversification away from UK sources of yield with an experienced fund manager adopting a growth approach not found in traditional valuation-sensitive yield-seeking,’ said Carruthers. Patient investors stand to benefit from an ‘exciting long-term trend’ of Japanese companies becoming increasingly comfortable with returning cash to shareholders. The trust yields 3.5%, paid half yearly.

Schroder Oriental Income (SOI) offers exposure to the Asian growth story. The trust has historically paid a fully covered dividend, which it has grown every year since launch in 2005. It currently yields 5.1%, paid quarterly. Having traded around net asset value for the last decade, its shares recently moved to a single-digit discount – an‘attractive entry point’, said Numis analyst Priyesh Parmar. Fund manager Matthew Dobbs (pictured) focuses on quality companies with improving corporate governance. He points to Asian companies weathering the last dividend bear market by allowing their pay-out ratios to increase, while the board has indicated its willingness to use reserves to support the dividend. FundCalibre and Canaccord Genuity are also fans of this trust.

Channel Islands wealth manager Ravenscroft scours the investment trust universe for ‘more interesting assets to gain exposure to’. Emerging markets are ideally suited to the closed-end structure. One trust it uses is Utilico Emerging Markets (UEM), whose fund manager Charles Jillings (pictured) seeks long-term total returns from companies operating in the infrastructure and utility sectors – energy providers, port operators and telecoms companies, for example. ‘Securing those returns from emerging markets, it seeks to minimise risk by selecting companies and sectors which display the characteristics of essential services or monopolies,’ said Adrian Clayton, an advisory broker at Ravenscroft. Many of them are throwing off cash and the trust yields 4.3% with dividends distributed quarterly.

In mid-May, the board of Jupiter Emerging & Frontier Income (JEFI) said prospects for underlying earnings remain good. ‘It’s confident enough to say that it will at least maintain the dividend for the year to 30 September 2020,’ said QuotedData’s Carthew. ‘The confidence is borne out of the managers’ preference for companies with robust franchises and strong balance sheets.’ Under Jupiter fund managers Ross Teverson (pictured) and Charles Sunnucks, the trust is well diversified but has more than 40% in Taiwan, China and Korea. It also has allocations to frontier markets like Kenya and Nigeria. That, coupled with gearing of 14%,makes this a pick for more adventurous investors. The trust yields 4.6%, paid quarterly.