2020, the Nadir for Income Investing

The year 2020 will be remembered for many things by financial market participants. To name but three we have experienced one of the fastest bear markets in history, the quickest recovery in history, and the biggest synchronised global fiscal and monetary stimulus the world has ever seen.

I am sure in the years to come 2020 will be remembered for other significant facts too and indeed in this article, I would like to offer up one that is both important and actionable. In my considered opinion, 2020 will be seen as the nadir for income investing, especially but not exclusively, for UK-based investors.

Last year was certainly the Annus Horribilis for income stocks as dividends were cut for three separate reasons:

1. Certain dividend-paying stocks that were consumer-facing saw their revenue cut to almost zero and therefore had no money to pay dividends
2.For banks and recipients of Covid relief payments, dividends were either mandated to zero or strongly encouraged to be passed
3. Managements took a conservative view of the post-pandemic future and suspended dividends to preserve cash (many companies who did so have already restarted distributions)

On top of all this, several UK-based mega-cap companies (such as BP, Shell, BT and Imperial Brands) that had (at best) skimpy dividend cover from profits reset their dividends downwards to what appears to be more affordable levels. During 2020 dividends for the UK market as a whole fell by over 40%.

This all happened within an environment where stocks considered immune to Covid disruptions mostly resided in low or non-dividend paying sectors such as Internet, Electric Vehicles and Biotechnology.

Thus, investors fled from sectors and stocks which had previously produced good dividends into companies which produced rapid revenue growth, whether or not that was accompanied by commensurate profit growth (or any profit at all).

In the UK the situation was further accentuated by the final ructions caused by the failing of Woodford (one of the biggest funds in the sector) and knock on effects on to the Invesco Income range, another very large income franchise. And all this happened within a market that international investors were shunning due to perceived Brexit risk!

However, the good news is that often in investments the bad events of yesterday can create the opportunities for tomorrow. Having moved on from the worst of Covid, Brexit and the Woodford debacle, I opine that UK dividends are set to grow consistently from the current much more sustainable base of around 3%.

One can look forward in anticipation of mid to high single digit compound dividend growth. So, it seems plausible that income investing, particularly where it involves above inflation rates of dividend growth, should once again resume its role as a bedrock of portfolio construction.

Two examples of funds that are well placed to be beneficiaries of this are JO Hambro UK Equity Income and ASI UK Equity Income Unconstrained. Since inception in 2005 and 2009 respectively until the end of 2019 these funds compounded dividend growth at 11% for the former and 8.5% for the latter. The growth of JO Hambro is depicted in the chart below.

Source: JO Hambro

In the US and Asia dividend investing has also fallen out of favour. Despite constituent companies demonstrating their ability to increase dividends over the long term, the US Dividend Aristocrat exchange traded fund has performed poorly, as per the chart shown below.

Source: JP Morgan

And consider also the quote from Fiera Magna Emerging Market Dividend Fund; “As well as the portfolio as a whole trading at a 10% multiple discount to the benchmark, nearly 25% of the Fund’s holdings are currently at or above a 20% discount to their 5-year average multiple even on 2020 depressed earnings. The discount occurs even as the portfolio shows a return on equity (ROE) of 18% on depressed earnings and a 3-year earnings compound annual growth rate (CAGR) of 10% including this year. While the next 3 months may lack visibility for some of these stocks, the 1-2 year upside as fundamentals reassert themselves is considerable… This kind of undervalued consistent growth opportunity is where we see scope for a strong performance recovery.”

So, this fund gives high returns, decent earnings per share (EPS) growth and commensurate dividend growth off of a decent starting yield. What is not to like over the medium to long term?

Thus, the evidence points to the bad times being over for those seeking decent income and dividend growth from their equity portfolios. Income investing can and should return as a cornerstone of equity investing in the years to come and we are certainly finding plenty of opportunities around the globe to benefit from the resumption of this trend.

Important notice: The information contained in this document is of a general nature and does not constitute an offer to provide services and has been prepared for use by Retail Clients as defined by the FCA. The opinions and conclusions given herein are those of WHIreland and are subject to change without notice. No responsibility is taken for any losses, including, without limitation, any consequential loss, which may be incurred by acting upon advice or recommendations contained in this document. The value of investments and income from them may go down as well as up and is not guaranteed and you may therefore not get back the amount you originally invested. It should be remembered that past performance is not necessarily a guide to future performance. For our mutual protection, telephone calls may be recorded and made available to you on request and such recordings may be used in the event of a dispute.