Perspective

Coronavirus: preparing for investment income shock


Since the financial crisis more than a decade ago, investors have had to search much harder for income as cash savings rates have plunged. Many have looked to the equity market to help them achieve better income returns, attracted by the large numbers of companies increasing dividend payments to shareholders as they have grown.

It is likely that equities will continue to provide a relatively attractive source of income for those comfortable with the risks of investing in the stock market, however, dividend payments for most equity investors are likely to be lower than in previous years for the foreseeable future as a result of the coronavirus crisis.

Economic impact - as well as social pressure - will limit dividend payments

As has been well documented, the coronavirus crisis and oil price war are having a profound impact on economic growth and the cash position of companies. Many businesses in the most affected sectors such as tourism, hospitality, aviation and retail have cut or suspended dividend payments to preserve their cash reserves and protect the viability of their businesses.

Any company that has received government assistance to stay afloat will find it particularly difficult to justify maintaining their dividend payments to shareholders.  Even those companies that have ample financial capacity to keep paying dividends at the same level through a temporary profit dip are likely to adopt a cautious approach, given the high level of uncertainty and, in some instances, the social pressure surrounding the payment of dividends.

The charity sector already faces an income squeeze

We know this is an especially important topic for the charity sector, as voluntary income is under considerable pressure.

NCVO estimate that the sector will lose up to £4 billion in voluntary income as a result of this crisis, and we are speaking to many clients that are already feeling the impact on their own activities.  A survey by NCVO, CFG and the Institute of Fundraising highlight the difficult position many trustees are in; with charities expecting a 48% decline in income at the same time as a 43% rise in demand for their services.

The problem is compounded given a simultaneous drop in investment income.

Dividends are a crucial element of long-term total returns

It is extraordinarily difficult to replace dividends as they are a huge part of the returns over the long term. For instance, the FTSE 100 Index only returned about 0.4% between 1999 and the end of 2019. But, if you include dividends, that rises to over 120%.

Companies that have received government assistance will find it particularly difficult to justify maintaining dividends

The latest UK Dividend Monitor from Link Group analysed the impact of the coronavirus pandemic on UK dividends. Within a few days in the middle of March, UK companies cancelled payouts to shareholders worth a staggering £25.4 billion between now and the end of December this year.

This represents one third of the dividends Link had expected UK plc to pay over the rest of this year – before the crisis struck. By 5 April, 45% of Britain’s listed companies had already cancelled their payouts or are very likely to do so, an unprecedented figure.

Last week Royal Dutch Shell cut its dividend for the first time since the Second World War as the coronavirus pandemic and lower energy prices halved quarterly earnings. The company said that it will reduce its dividend by two-thirds. The company was the biggest dividend payer of the FTSE100 constituents in 2019. On the other hand, BP said it would maintain its dividend despite a 66% drop in first quarter profits – but added it would review distributions in the second quarter. 

Looking ahead

With so much uncertainty, it is difficult to predict what will follow and the situation continues to evolve daily. During the financial crisis dividend income fell by 18% globally and 15% in the UK. However, our view is that the impact is likely to be higher in the current situation.

Schroders’ economists currently expect a contraction in world GDP of just over 3% in 2020, the worst outcome since the 1930s. Investors fear that shutting down of much of the global economy in response to the health crisis will result in a collapse in consumption and widespread corporate distress.

The shape of the recovery from the coronavirus crisis remains far from clear. There are indications that the strict lockdown conditions in place in many countries could be relaxed reasonably soon, enabling some limited activity to resume.

Realistically we all face a long wait for anything approximating "business as normal", given that the only route to achieving this appears to be the development and implementation of an effective vaccination programme on a global scale.

This is unlikely to come together until well into next year, even if one of the vaccines that have already begun human trials proves effective.

This means that dividend payments over the next few years are likely to remain well below levels seen in 2019. There is no precedent for the current crisis, but estimates of the eventual cut in dividends for the UK market as a whole in 2020 have so far ranged from around 25% to as much as 50% and for global markets a range of 20% to 30%. Investment income from a diversified portfolio is likely to be less impacted, but the impact is still significant.

Requirement to balance stakeholders' interests

This is largely dependent on how long it takes to bring the pandemic under control and ending the restrictions in force across much of Europe and the US.  Companies and asset owners will be expected to balance all their stakeholders' interests and prioritise liquidity, employees and small suppliers, ensuring the long term sustainability of their businesses. There are a number of well capitalised companies where their regulator has steered them to cancel dividends, and in these circumstances the payment of dividends may be deferred – rather than cancelled altogether.

Clearly, the implications for the sector are meaningful. We are working with our charity clients to understand the impact of these forecast income falls on individual budgets and how we can best support them. 

Please get in touch with your usual Cazenove Charities contact if you have any questions.

 

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

Contact Cazenove Charities

Achieving your charity's investment objectives takes time and thought. To find out how we can help you please contact:

James Brennan

James Brennan

Portfolio Director james.brennan@cazenovecapital.com