It goes without saying that 2020 has been something of an annus horribilis for income investors, with swathing cuts across the board thanks to Covid-19. Nowhere has been safe, with many firms choosing to cut dividends to preserve cash in lockdown, while others were put under pressure or simply prevented from paying out. 
But while the headlines look negative, there’s also been some talk of this being a good thing for companies to reset their business models. Many had got into the bad habit of increasing payouts to please investors, rather than necessarily doing what was right for the company. Now they have the opportunity to reset dividends to a more manageable and sustainable level, and also to reinvest in the business again, which is better for the company’s long-term future.
That may all sound good for the long-term but plenty of investors need those dividend returns now – and let’s not forget that it is the re-investing of dividends which drives returns. The FTSE 100 currently has a dividend yield of 3.23 per cent (as at 11 November). Contrast that to the end of 2019, when it stood at 4.35 per cent.
When will dividends recover?
While many companies have been cutting, there are a number of big companies that have managed to maintain their dividends, including Unilever, Reckitt Benckiser, GlaxoSmithKline, Jupiter financial Management and Rio Tinto.
And figures from Link Asset Services show there may be some green shoots on the horizon for income starved investors. That’s despite UK dividends falling almost 50 per cent in the third quarter of 2020 year-on-year, with only two sectors – food retailers and basic consumer goods – delivering slight increases, according to the Link Dividend Monitor.
Two-thirds of companies cut or cancelled payouts in Q3, but that was down on the 75 per cent who did so in the previous quarter – but the positive is that some are starting to pay out again, such as BAE Systems, IMI and Direct Line.
Link now expect dividends to be cut to the tune of £60bn in 2020 – but the recovery starts thereafter with estimates of between a 6-15 per cent rise in 2021.
Much of the recovery will be sector-specific. Sectors such as oil, real estate, leisure and retail are unlikely to return soon to where they were – if ever – with many changes being structural.
A second lockdown now being in place may slow the dividend recovery – but there are some promising signs. With this in mind, here are four funds we feel are good options should UK dividends be back on the agenda.
One of the first places to look might well be the maligned – and quite frankly battered – value sector. There are a few reasons for this. Firstly, the Bank of England is considering allowing banks to start paying dividends again; Sainsbury’s has already announced plans to re-instate dividends; while there are also prospects for cyclical miners – all of which leads to the value sector. I would look at names like the Schroder Income fund or The City of London Investment Trust – which of course can also use its revenue reserves to maintain its own dividend.
Another fund with more of a balanced approach is the GAM UK Equity Income fund. Manager Adrian Gosden’s process for selecting and valuing companies is based on how much spare cash each business generates and their ability to pay dividends with this cash. Idea generation starts with a basic filter of the UK stock market to find companies with these good free cash flow metrics. From here, they will do an industry assessment to understand what environment a company is operating in, including on regulatory considerations, competitor analysis, and pricing power.
I’d also consider a multi-cap offering, given the additional flexibility they offer. Marlborough Multi Cap Income fund invests in a combination of FTSE 350 and much smaller companies, with a premise that these firms tend to outperform over the long run. Manager Siddarth Chand Lall sources ideas from the team and a network of brokers, studying financial statements and using models to test the sustainability of dividend payments. Management meetings are key and 65 per cent of the fund is in stocks with a market cap of less than £1bn.
Juliet Schooling Latter is research director at FundCalibre. The views expressed above are her own and should not be taken as investment advice.