EQUITY-INCOME STRATEGY TAKES A HUGE HIT

INVESTORS SET TO LOSE NEARLY US$ 500B IN DIVIDEND PAYMENTS

When global equity markets lost around US$16 trillion of their value in a single month this year, the wealthy found themselves no more protected from financial loss than anyone else.

According to the Bloomberg Billionaires Index, the world’s 500 richest people collectively saw nearly US$950 billion evaporate in the first 10 weeks of 2020, a 16 per cent fall. Most of it went in the four weeks from mid-February to mid-March, including US$330 billion on a single day, Thursday March 12.

Those with the luxury of a long-term perspective can hope for an eventual share price recovery. Even if this is years away, history suggests it will come. But those with more urgent financial needs must accept a painful reality: investors stand to lose up to US$490 billion of dividend payments in the full calendar year, based on the preliminary worst-case forecast for the Janus Henderson Global Dividend Index.

For all investors — whether they are reliant on dividends for income, or simply reinvesting them — this loss will have been immediately felt. “Given that the portfolio return is a function of income received and capital gain, this is clearly bad news,” says Simon Pinckney, managing director at wealth manager Hassium. “These suspensions impact portfolios by way of lower income received and usually by share price depreciation too. It also raises anxiety and the market risk profile, as people fear that more dividend suspensions will follow.”

Suspensions have been necessitated by both economic and political pressures, as COVID-19 has spread. Alexandre Tavazzi, global strategist at Pictet Wealth Management, points out that collapsing earnings leave little to fund shareholder payouts, and government business relief schemes make it hard to justify paying anything.

In the U.K., leading supermarket Tesco drew criticism for maintaining a £900 million dividend while benefiting from a £535 million tax holiday. Similarly, in the U.S., campaigners balked at five airlines — Delta, American Airlines, United, Southwest and Alaska — seeking a US$50 billion bailout after paying out US$45 billion to shareholders and executives in the previous five years.

“Since the purpose of these liquidity injections is to support all participants of the economy, there is a strong will to avoid directly benefiting company shareholders,” Tavazzi explains. Investors need to be quicker to grasp the political reality, though: “It is clear that markets have not yet anticipated the impact that regulatory pressure will have on dividends.”

How investors should react to the loss of their twice-yearly payments depends on how they use them, wealth managers say.

Anyone requiring regular income may need to reselect their holdings — swapping investments in indebted or regulated businesses for those in groups with more cash flow and more freedom from government pressure. Getting out of banks and airlines and into consumer goods groups, for example.

“Over are the days when companies could issue debt to buy back shares and pay dividends,” says Tavazzi. “For us, when it comes to stock selection, those companies that are self-sustaining and not reliant on government intervention are those best positioned to maintain their dividends.”

However, anyone who was using the income to add to their holdings should continue to do so, advisers recommend. They may even find that some of these holdings recover in value as the market begins to distinguish between prudent dividend cuts made by stronger companies and cuts forced on weaker competitors.

“We would expect to see ... many household names suspending or cancelling payouts,” argues Oliver Smith, investment director at the family office Sandaire. “Inevitably this will result in lower dividends for client portfolios, but the fact companies are cutting dividends is not being taken as badly as it would in the good times.”

Shares in packaging group DS Smith even rose slightly when it scrapped its interim payout as a precaution, as investors noted the strong demand for its cardboard boxes from food and e-commerce clients.

Duncan Burden, head of research at Stamford Associates, the investment consultancy with US$72 billion under advice, suggests this is partly because the rationale behind most suspended and cancelled payouts is understood.

“Dividend cuts preserve capital — they may not be a negative signal . . . many of the dividend cuts witnessed in recent weeks have been made pre-emptively to retain future flexibility . . . The cuts do not necessarily reflect lasting impacts on their business models.”

In some cases they may even strengthen business models, he believes, if they encourage company managements to allocate capital more productively as the crisis relents.

A far bigger risk than cancelled dividends is weakened balance sheets, on Stamford’s analysis. “Focus on the right thing: be wary of debt covenants,” says Burden, referring to loan agreements with lenders, which can constrain management. “Capital structures that were considered conservative before the Covid-19 pandemic may no longer be so as profits fall. Any amount of debt on an earnings base approaching zero may put perceptibly more ‘defensive’ businesses at risk of a covenant breach.”

If fundraisings are then needed, it will again be for investors to distinguish between the temporarily weakened businesses and the longer-term struggling groups. “There is a huge difference between companies pursuing ‘rescue rights issues’ . . . and those raising capital to bridge temporarily choked cash flow through no fault of their own,” Burden counsels.

Ultimately, the impact of the coronavirus on companies and economies may force a reappraisal of dividend stocks — by income seekers and reinvestors, and by wealthy and smaller savers alike.

Portfolio managers expect many of the dividends currently suspended will be resumed — although, as Pinckney at Hassium observes, “It remains to be seen if it will be at the same level as before, and when.”

For this reason, he reckons all holdings “will require reappraising during and after the crisis — and the ability to pay consistent dividends back to shareholders will be a part of that reappraisal.”

At accounting and advisory group Mazars, the expectation is that the appraisal will be based on the length of recovery time for industries after the pandemic. Its chief economist George Lagarias forecasts that utility companies should not feel too much of a disruption, but hospitality and leisure groups could face multiyear losses, and multiple missed dividends.

For others, though, the COVID-19 crisis makes a review of asset allocation, more generally, advisable. A mixed asset approach can allow other holdings to be sold to provide capital to live on, says Smith at Sandaire.

“While the equity sell-off has been very unnerving, clients investing across the asset classes have seen their fixed income allocations hold up much better, or even make modest gains, allowing for bonds to be sold without impacting the long term growth prospects of the rest of their investments,” he explains.

The experience of losing money could lead to losing an attachment to equity income strategies.

Pictet expects coronavirus disruption will push some companies’ dividend yields lower than their bond yields, prompting a possible change in approach for investors. “This places equity holders at a disadvantage to bondholders and dividend stocks will have to be reassessed along with all income strategies in equity markets,” advises Tavazzi. “We will continue to focus on self-sustaining companies, especially now that the era of business financing at low rates for all is over. As such, this makes the reappraisal of dividend stocks necessary.”