With dividends badly hit by coronavirus, where should investors turn?
New report says investors need to look beyond dividends
Mon, 06/08/2020 – 12:07
Dividend-paying UK shares have always been popular with investors, but many firms are now cutting their payments as a result of the coronavirus pandemic.
This is likely to continue for some time, according to consultants Lane Clark & Peacock (LCP), and investors will need to look elsewhere to get steady income from their holdings.
LCP does not expect firms to start paying out any time soon, hitting savers who rely on dividends for their retirement.
It estimates that £260 billion of private pension assets will enter decumulation – the process of converting pension savings to retirement income – over the next 10 to 15 years.
Data from the Financial Conduct Authority shows people retiring usually expect to withdraw around 8% of their fund, which would hit decumulation cash in the short term.
In a new report, LCP suggests investors could replace any lost income by investing in infrastructure, high-yield and emerging market debt, and private credit.
What are dividends?
Dividends are the amount of a company’s profits that are returned to shareholders in the form of a payment.
For some investors, stable, high dividend payments are an essential reason for owning the shares they do – they use them to pay bills or, if they get enough back, to live on completely. Other people chose to reinvest dividends straight back into shares in order to take advantage of compounding.
How badly have dividends been hit?
Lots of businesses have suspended dividend payments in order to stay afloat.
FTSE-100 companies have regularly paid substantial dividends, but firms have already made cuts of £30 billion this year to shore up their balance sheets.
Some of Britain’s banks, including HSBC, Barclays and Lloyds have announced they are scrapping dividend payments. Meanwhile, Royal Dutch Shell has cut its dividend for the first time since 1945.
It is not just the coronavirus pandemic which is affecting dividend payments.
Between 1986 and 2010, high-dividend UK shares paid out annual income of around 4-6% per year on average.
However, in the five years leading up to March 2020 UK savers have been losing 20-30% of their capital value, while 10 stocks are likely to be responsible for two-thirds of all dividends in the UK.
Dan Mikulskis, a partner at LCP, says: “Investors and their advisers need to think more creatively about ways of generating income. The good news is that there are many ways of investing, already widely used by large institutional investors, which offer routes to generating income and spreading risk.”
Where should investors look to?
The report suggests investing in infrastructure projects as they tend to have long lifespans and stable cash flows, earning income from consumers and businesses that need their services even during times of recession.
Infrastructure projects often require a large up-front investment to develop, which is recouped through a long-term stream of fairly reliable income.
Investing in companies listed on the stock exchange such as the National Grid makes it easier for investors to sell their shares.
High-yield and emerging market debt
LCP says another possible solution is to invest in debt, a strategy that institutional investors like pension funds have employed.
Rather than buying shares, this form of investment involves buying the debt of a range of companies and countries, although high yields tend to be associated with higher risk of default,
LCP says that provided that the portfolio is suitably diversified and well-managed, additional returns from this investment will tend to outweigh the loss from individual defaults.
Smaller companies can struggle to raise capital through issuing shares or bonds or through bank lending.
The difficulty these firms have had in borrowing money from banks since the financial crisis has allowed asset managers to step in and lend money directly.
These loans generate an income in the form of interest, but as the private credit investments are illiquid – they cannot easily be sold on to another investor.
Investors will typically have to wait around seven years to recoup the interest and maturity payments.
Because this inconvenience, these sort of investments will typically offer a higher rate of return (or yield) compared to a listed corporate bond.