The Great Dividend Crisis
What can income investors do?
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
The old order of dividend-paying companies has been overthrown by the coronavirus pandemic. The task now, writes the co-head of Baillie Gifford’s equity income strategies, is to take a long hard look at the potential winners of the future.
Unprecedented. That is the only word to describe the ongoing collapse of corporate dividends. 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 the coronavirus (Covid-19) pandemic. 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 – again understandable given that many currently have no revenues. Likewise 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 managing to collect.
Equally shocking is the speed of the reversal: often dividend payments proposed only weeks ago are being withdrawn from Annual General Meeting schedules in April and May. Again, unprecedented.
What on earth can be done by dividend investors in the face of this crisis? 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, our recommendations are the same.
Let’s start with what we think they should not do. There will be a great temptation in the weeks and months ahead 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.
In our view, 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 end up destroying capital value. Why? Because earnings and dividends ultimately determine capital value, and many high-yielding companies suffering large drops in earnings and dividends will simply not, in our view, see a bounce-back to the levels they enjoyed before the coronavirus struck. For many such companies we anticipate a permanent impairment of their dividend paying ability.
It is important for dividend investors to remember that before Covid-19, high street shops and retail REITs were already under intense pressure from ecommerce. Oil companies were already fighting a losing battle against the long-term decline in hydrocarbon consumption. Banks were riding an unusually long wave of near-zero loan losses. Carmakers and airlines, viciously competitive industries for decades, were in most cases making no economic profit. In other sectors, many companies were simply over-distributing capital, whether in buybacks or excessively high dividends.
Once the world defeats Covid-19, these companies are highly unlikely to see their earnings and dividends resume at pre-crisis levels. Established trends are simply being accelerated by the current crisis. There will be no ‘reversion to the mean’. Many companies are facing a dividend reset, not a V-shaped bounce.
Purchasing these troubled companies in the hope they will pay high dividends that plug the gap is therefore a doubly dangerous game. Not only is the dividend uncertain in the near-term, but as investors digest the reality of these companies’ permanently impaired earning power and dividend-paying ability, their capital value post-crisis is unlikely to rebound. This is true risk – the permanent impairment of capital value.
What about the less cyclical high-yielding sectors that income investors have traditionally turned to, such as utilities, tobacco, and telecoms companies? Unfortunately these are mature sectors, fraught with regulatory risk, and with weak long-term growth prospects. They may offer some near-term security of income. But the investor who piles into these sectors to plug this year’s income hole will face the near-certainty of very dull long-term profit growth. It is not a coincidence that many companies in these ‘low-risk’ sectors, from Vodafone to Centrica, have failed to deliver profit growth over long periods – and in many cases have had to rebase their dividends.
Now for the good news. Happily, there is also a huge opportunity in the current environment. It does, however, require the right mindset.
The beauty of equity markets is that, as an active investor, you can avoid the companies and business models of yesterday and invest instead in the shares of the future. That may limit your dividend income in 2020, as these companies have a lower yield than others which are ex-growth. But in the long-term, if you find these companies, it is likely to pay off in far higher levels of income, together with strong capital appreciation.
For every company facing a prolonged period of troubled times, there is another for which Covid-19 will ultimately prove transitory. Great companies with relevant business models will undoubtedly see earnings and dividends bounce back.
Well-run insurance companies, for instance, will continue to play a vital role in protecting policyholders against disasters – and the value of that insurance may well be higher in a post-pandemic world. Innovative manufacturing companies, with products that genuinely enhance the efficiency of their customers, will see their earnings bounce back too.
Delivery companies will find their services in ever-greater demand. Restaurants which are happy to deliver as well as host diners will surely thrive. Even in the property sector dividend investors can anticipate that well-invested residential assets, in a post-virus world of Zooming and flexible home-working, will generate solid rental income.
The challenge is to make sure that you, as an investor, or else your dividend fund manager, exercise the discipline to invest in these businesses of the future, rather than clinging to the high-yielders of the past. Even if doing so means moderating dividend income in the short term.
The question for dividend investors to ask therefore is not “What companies can I buy to plug this year’s income gap?” It is rather: “What companies do I believe have a strong future once this crisis has passed?”
Our mantra as income managers at Baillie Gifford is “long-term income, not short-term yield”. The yields on the funds we manage are by no means the highest in the income universe, because we have been longstanding advocates of sacrificing short-term yield in the pursuit of better long-term income and capital growth. We have shunned many of the sectors and companies that are now struggling profoundly. This approach has delivered stronger total returns than most short-term yield-focused funds, as well as providing an income which has risen over time.
Be demanding of the businesses you invest in. If you’re investing for long-term income, set a high bar that only accepts genuine growth businesses. In our experience companies that can grow their earnings to support higher dividends in five or ten years’ time are far more rewarding investments than short-term ‘yield plays’. That is why we largely avoid the mature, ex-growth companies that have propped up the market’s yield.
In assessing dividend resilience, we aim to avoid companies that are capital-intensive, or highly cyclical, or are simply distributing cash in a way that is not in the long-term interests of their business. We use a checklist for dividend dependability which penalises companies for these and other weaknesses. Discipline in observing these risks, focusing instead on companies with stable, cash generative business models, will greatly enhance your long-term income and capital prospects.
Despite our best efforts we still make mistakes. An example is Bankinter, the Spanish retail bank. As the highest quality bank in Spain we had foreseen it taking market share from its weaker local competitors. But we now expect that government support for the entire banking sector will put pressure on balance sheets and dividends for a long period of time. We mis-calibrated the regulatory risk here, and we do not anticipate that Bankinter’s recently-suspended dividend will ‘bounce back’ any time soon.
We therefore sold our holdings and, in re-investing the proceeds of our sale, we asked ourselves the question posed above: which companies have a strong future once this crisis has passed? We invested into companies where we have great confidence in their long-term prospects, even if they don’t have the same high yield that Bankinter had before recent events. We added to our holdings in Deutsche Böerse, Nestlé and Roche, for example.
Do be careful about the UK market. A UK-only approach to dividend income is extremely narrow. There are roughly 250 dividend-paying companies in the UK, not a huge number for an active stock picker, and the market is dominated by companies in structurally challenged industries. Many are paying out too much in dividends rather than re-investing for the future.
Worldwide, there are about 4,500 dividend paying shares that you, or your dividend fund manager, can choose from. Many of these are great companies with strong business models that will remain relevant for years to come.
Again, you have an opportunity to take the long-term view. Going global, as we did for our own funds in 2011, will allow you the chance to escape from the risks of the UK oil companies, the banks, the high street retailers, and the other troubled companies that make up so much of the UK dividend sector. Instead you will become free to choose the well-run insurers, the value-add manufacturers, the delivery companies and so on that will thrive in the future. Your portfolio will be far more likely to bounce back from this crisis. Our own experience has been that going global is incredibly liberating and rewarding.
Dividend investors can survive this unprecedented setback. They can do so by exercising the discipline of a long-term approach and actively picking the winning companies of the future. With a global portfolio of these names, there is a terrific opportunity for your income and capital to bounce back stronger than ever.
Important Information and Risk Factors
The views expressed in this article are those of James Dow and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
James Dow wrote the article contained in this communication in April 2020 and no updates have been made since then. It represents views held at the time of writing and may not reflect current thinking.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this article are for illustrative purposes only.
Annual Past Performance % to 30 September Each Year
2016 2017 2018 2019 2020 Global Income Growth 10.9 16.7 6.8 5.5 14.1 FTSE All World 12.6 19.3 10.2 1.9 10.9
Source: Baillie Gifford & Co, US Dollars, net of fees.
Changes in the investment strategies, contributions or withrawals may materially alter the performance and results of the portfolio.
Source: London Stock Exchange Group plc and its group undertakings (collectively, the ëLSE Groupí). © LSE Group 2020. FTSE Russell is a trading name of certain of the LSE Group companies. ëFTSE All Worldí is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. ëTMXÆí is a trade mark of TSX, Inc. and used by the LSE Group under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group companyís express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018 and is authorised by the Central Bank of Ireland. Through its MiFID passport, it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (“FinIA”). It does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. It is the intention to ask for the authorisation by the Swiss Financial Market Supervisory Authority (FINMA) to maintain this representative office of a foreign asset manager of collective assets in Switzerland pursuant to the applicable transitional provisions of FinIA. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co.
Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Room 3009-3010, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Telephone +852 3756 5700.
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.
The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission. Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.
Baillie Gifford Overseas Limited (“BGO”) neither has a registered business presence nor a representative office in Oman and does not undertake banking business or provide financial services in Oman. Consequently, BGO is not regulated by either the Central Bank of Oman or Oman’s Capital Market Authority. No authorization, licence or approval has been received from the Capital Market Authority of Oman or any other regulatory authority in Oman, to provide such advice or service within Oman. BGO does not solicit business in Oman and does not market, offer, sell or distribute any financial or investment products or services in Oman and no subscription to any securities, products or financial services may or will be consummated within Oman. The recipient of this document represents that it is a financial institution or a sophisticated investor (as described in Article 139 of the Executive Regulations of the Capital Market Law) and that its officers/employees have such experience in business and financial matters that they are capable of evaluating the merits and risks of investments.
This strategy is only being offered to a limited number of investors who are willing and able to conduct an independent investigation of the risks involved. This does not constitute an offer to the public and is for the use only of the named addressee and should not be given or shown to any other person (other than employees, agents, or consultants in connection with the addressee’s consideration thereof). Baillie Gifford Overseas Limited has not been and will not be registered with Qatar Central Bank or under any laws of the State of Qatar. No transactions will be concluded in your jurisdiction and any inquiries regarding the strategy should be made to Baillie Gifford.
Baillie Gifford Overseas is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This document is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.
49641 INS AR 0759
JAMES DOW Co-head of Global Income Growth
James was appointed co-head of the Global Income Growth Team and co-manager of The Scottish American Investment Company P.L.C. (SAINTS) in 2017. He joined Baillie Gifford in 2004 on the Graduate Scheme and became an investment manager in our US Equities Team. Previously, James spent three years working at The Scotsman newspaper, where he was the Economics Editor. He is a CFA Charterholder, graduated MA (Hons) in Economics-Philosophy from the University of St Andrews in 2000 and MSc in Development Studies from the London School of Economics in 2001.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Management Metamorphosis.Almost unnoticed, Japanese management is changing for the better. Head of Japan Donald Farquharson looks at the transformation drawing on the experience of three decades of engagement.Climate Change: Risk or Opportunity?Alicia Cowley, member of the Asia Client Service Team, is joined by ESG specialists Marianne Harper Gow and Michelle O’Keefe to discuss the burning question: Does climate change pose a risk to investment returns or are we able to identify investment opportunities in this area?The Future of Mobility - Part 3.A wave of revolutionary new technologies is set to transform the way we travel from A to B. In this short series, Thaiha Nguyen, a Baillie Gifford investment manager, takes an in-depth look at the business of personal transport on the brink of change.