The wave of Covid-induced dividend cuts is forcing many UK investors to re-evaluate their saving strategies. Yet even before the current crisis, UK dividends were a cause for concern, with data already pointing to lower figures for 2020. 
Although UK dividends reached new highs in 2019, the Link Dividend Monitor for Q4 2019 attributed the record headline figure of £110.5bn to £12bn of special dividends. Excluding these unpredictable one-off payments, underlying dividends increased at the slowest rate since 2014, rising just 2.8 per cent – and 0.8 per cent excluding FX gains. For 2020, Link forecasted a 7.1 per cent fall in headline dividends and a 0.7 per cent fall in underlying payouts.
More worrying was dividend cover, which has remained below 2x since 2014. Companies had little leeway to uphold payments if profits were lower than expected – which has transpired as a result of the global pandemic.
This is not to say UK dividends are doomed. Current difficulties merely offer a moment of reflection for investors to reassess priorities and rethink income allocations. Saving for the long term requires an unwavering focus on companies putting future growth first – even at the expense of short-term returns. Meanwhile, a prudent saving strategy calls for careful diversification.
Niche small-cap dividend stars
If the troubling underlying trends were largely inconspicuous prior to the Covid-crisis, the sudden halt in dividend payments has brought the plight of UK dividends into sharper contrast. According to AJ Bell, the total forecast dividends for 2020 is on course to be the lowest in six years, at £63bn, with total cuts estimated at £31.6bn.
With £26.5bn – more than 80 per cent – of the cuts coming from FTSE 100 firms, the current crisis has reminded investors of the importance of diversification. Historically, savers have relied on FTSE 100 companies, but there are plenty of income-generating small caps with more consistent payout policies.
Instinctively, smaller companies may appear more vulnerable to economic difficulties, but we look for companies dominant in niche markets, which are relatively insulated from macro-dynamics. If anything, this misconception provides an attractive entry point into smaller companies, which are trading at a substantial discount to large caps currently.
For example, Bioventix is an R&D company focused on producing antibodies for clinical diagnostics and pharmaceutical research. Due to its highly cash generative business model, the £220m market cap company – which has a dividend yield of 2 per cent – has a fantastic record of dividend growth over the past few years, with a 30 per cent CAGR (compound annual growth rate) over five years. This means if you bought the shares on 1 July 2014, more than 80 per cent of your original cost would have been returned in dividends and your capital would have appreciated by 750 per cent.
Another little-known consistent dividend growth story is Anpario, which is an £85m market cap natural animal feed additive producer for global agriculture and aquaculture markets. The company offers a 2.3 per cent dividend yield and has seen 12 per cent dividend per share CAGR over the past five years, with a dividend cover well over 2x.
Securing future income streams
While hunting down the market cap spectrum can unearth dividend warriors to alleviate the ongoing drought, investors should not stay fixated on current payouts. Now is the time to focus on high-quality promising businesses, which have the capacity to grow and pay dividends in the future.
The Baronsmead VCT portfolios blend earlier stage unquoted businesses, which provide access to capital growth upside, as well as more stable income-generating AIM stocks. This unique approach allows us to identify the dividend payers of the future, while maintaining a regular income stream.
By taking smaller initial stakes in a broad range of early-stage companies, we can manage downside risk as we assess the business growth potential. We then focus on the best businesses, providing further capital and expertise. If a company scales up and becomes a listed reliable dividend payer, we can also invest in it through our other open-ended equity funds.
Ideagen is one company we have our eye on for future returns. The market-leading provider of governance, risk and compliance software solutions already pays a dividend and, as it matures, will form an increasing proportion of our overall return. This is a stock we invested in originally at 19p in 2013, and it is now trading at 187p.
The Covid-19 crisis is the opportune moment for investors to re-evaluate current income allocations and place more of an emphasis on the future. It is time to broaden your income horizons and embrace the qualities of non-traditional dividend distributors, such as smaller companies and closed-ended funds.
Ken Wotton is investment manager of the Baronsmead VCTs. The views expressed above are his own and should not be taken as investment advice.