For many charities, the income that they receive from their investment portfolios is vitally important. The recent run of UK companies that have either cut or suspended their dividend payments, therefore, is particularly unwelcome.
Over the course of the past year, companies from a range of different sectors such as Barclays, Centrica, Tesco, Rolls-Royce and Rio Tinto have all cut their dividends or announced plans to do so. They are not alone. The latest Dividend Monitor research published by Capita Registrars shows that underlying dividends, i.e. excluding special dividend payments, are expected to fall by 1.7% in 2016. This is perhaps a relatively small number but it represents the first cut in aggregate UK dividends since the financial crisis and suggests that there is more pain to come for the rest of the year.
It could get worse, too. Most large oil and gas companies have so far maintained their dividend payments despite the sharp fall in the oil price, but only by increasing their borrowing, which we believe is unsustainable in the long term. Fluctuations in the value of sterling could also be a factor given the high number of UK-listed companies, such as GlaxoSmithKline or HSBC, who declare their dividends in US dollars. In the first quarter of this year the weakness of sterling added £350m to the value of UK dividends, offsetting some of the dividend cuts, but any reversal of this trend could impact dividends in the future.
So what can we, as a charity investment manager, do to rotect our clients? In the first instance the answer is to diversify. We typically spread investments not only across different companies in different industrial sectors but across different geographical regions and across a range of different asset classes, too. This has the effect of limiting the impact of any dividend cut at any one individual company and, with the benefit of some astute research, increases the chances of achieving income growth in other areas to compensate. Indeed, over the past few years we have been broadening client portfolios to include a range of alternative assets that typically offer attractive and more secure levels of income. But that is not enough and so we have gone further.
Earlier this year our Research Team carried out a study into the risk of dividend cuts and compiled an analysis of the safety, or otherwise, of UK dividends paid by a wide variety of companies. We studied 35 years of monthly historic data to examine how many instances of dividend cuts had actually occurred during that time and how the probability of a cut changed depending on the level of the dividend yield. Our analysts then estimated the probability of a dividend cut for each of the companies for which they provide recommendations. The results are instructive.
As well as the intuitive result that large companies are less likely to cut their dividends than smaller companies, we also found that there is a slightly greater chance of a dividend cut for companies that offer a dividend yield of between 0% and 2% than for those who offer a dividend yield of between 2% and 4%. For dividend yields above 6% the chances of a dividend cut rises rapidly, highlighting how a high yield can often reflect the market expectation that the dividend is not sustainable. We are already using this research to influence how we invest for our clients, helping to reduce the risk of cuts to income which will also support total returns, given that a cut to the dividend is often accompanied by a fall in a company’s share price.
By Ian Burrows Divisional Director
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