The Covid-19 pandemic has had a significant impact of income investors in the past couple of months as rates on lower-risk government bonds have turned negative and risker dividend-paying equities have been forced to cut or postpone payouts to cope with the economic impact of the crisis.
As such, in a time of higher uncertainty over dividend payouts and low interest rates and economic contraction are there actually any options left for income investors?
Schroders multi-asset strategist Ben Popatlal and multi-asset fund manager Dorian Carrell said there are two options available for investors in the current environment: they can either “chase a diminishing pool of developed market dividends” or diversify their income streams.
The problem with chasing a shrinking pool of dividend-paying companies, said Popatlal and Carrel, is finding a portfolio with a significant amount of dividend concentration.
Dividend concentration has been a particular problem for the industry for a number of years, with managers increasingly crowding into a smaller pool of high dividend stocks.
“In Europe, for example, three sectors account for over 50 per cent of total dividends paid out to shareholders,” the Schroders pair said. “This can result in higher concentration risk in portfolios than individuals investing in a diversified income portfolio would want.”
In addition, several of these sectors are looking “worryingly over-stretched” in terms of how much debt they have on their balance sheets relative to history, the pair noted.
“This leads to legitimate questions about how viable a number of these businesses will be in a post-Covid-19 world,” they said.
“Things are likely to get worse. The approach to managing an exit from the Covid-19 shutdowns is not yet clear and it seems likely that global businesses will be forced to adopt a more conservative financial approach to get through this period by protecting their balance sheets.”
Indeed, earnings are expected fall “dramatically” in the US as a result of lockdown conditions, according to Schroders models, with a similar picture expected in both the UK and Europe.
And during recession periods, as many experts say the global economy is currently experiencing, dividend cuts typically follow lower earnings, said Popatlal and Carrel.
Lower dividends are also a concern in the US, they said, albeit with the added prospect that companies will begin reducing or suspending share buybacks – “a popular and tax-efficient way of returning wealth to shareholders by reducing the share count and boosting earnings per share”.
“In fact, for equity investors across the world, an additional feature of aftermath of the coronavirus crisis is likely to be companies supporting their balance sheets by choosing to issue equity rather than debt,” they said. “This is effectively a buyback in reverse, boosting the number of shares outstanding and diluting earning per share.”
With the dividend outlook for developed markets looking challenging, the Schroders multi-asset pair said investors should look elsewhere for income alternatives.
“The search for sustainable income in the current environment can be daunting, but opportunities are clearly emerging,” said Popatlal and Carrel.
“In this environment we prefer securities with fixed rather than discretionary distributions and those that are higher up in the capital structure – so more likely to get paid,” they said.
Fixed income examples in the Schroders multi-asset portfolios include high quality credit, preferred securities, real estate investment trusts (REITs) and convertible bonds.
From an equity perspective, they said, Asia looks more attractive from a yield perspective and – as a region – has come through the Covid-19 crisis “relatively unscathed”.
“Looking ahead, we think that in the turbulent and uncertain aftermath of the coronavirus crisis, being nimble and fleet-footed will be the best way to protect investors’ income streams,” the pair concluded.