The income outlook

For financial professionals only

Hot on the heels of the stock market sell off comes further disappointment for income orientated investors. The media has been full of news that dividends are being cut, with dividend futures (indicating the market expectation of future payments) showing a plunge of around 50% in Europe. For those relying on their portfolio income, this is an unsettling prospect.

Dividend suspensions are understandable – particularly in the case of banks, who we depend on for the short-term security of our economy. But stronger cash reserves in the banks is little comfort for anyone facing a loss of income.

It’s not all about dividends

To understand the impact on investors, it’s worth thinking about what our multi-asset portfolios are essentially made up of. The property funds, though presently gated, are still receiving their commercial rents and, at the time of writing, still expect to pay their normal distributions.

The lower risk element, fixed income, is populated with bonds – these are basically loans to governments and businesses, in exchange for an interest rate, over a fixed period of time. We don’t expect those governments to go bust, so there is some security in that element. As for corporates, assuming they remain solvent, they have an obligation to service their debt in a way that does not apply to the equity side. If companies do enter liquidation, they have to repay the capital to lenders (ie, bondholders) where possible, which again is unlike shareholders.

That’s because, unlike bonds where you lend your money to a business, equity means you buy a share of the business. As a result, you share in the profits and growth of the company when things are going well. Unfortunately, you share the downside, too.

At present, many companies have lost all revenues. With no certainty of when normality will resume, they have to preserve the cash they hold so they can keep operating when that time eventually comes. In addition, if a business stands to benefit from support from central government, it’s hardly appropriate to continue to pay out to shareholders.

Income from Parmenion portfolios

As investment managers, we can’t control the actions of underlying companies held by our underlying funds. But by investing in funds rather than directly in specific companies, we have the benefit of diversification, which should mean we have exposure to companies that benefit from the current situation, as well as those adversely affected. Supermarkets and online retailers, for example, are seeing record activity.

Beyond this, we are selective on which funds we hold. Our robust due diligence approach, with its focus on risk first, means our chosen active equity income managers broadly look for companies with strong balance sheets and reserves. Those managers were conscious, even before the pandemic, that dividend cover (the ability for companies to comfortably pay dividends at a consistent rate based on their earnings) across the UK stock market, was low. In light of this, they were already positioning to protect their income generation.

Our fixed income managers are likewise selected based on their management of risk, as well as returns. To that end, they look to invest in bond issuers who they are confident can meet their covenants. Again, in line with our risk based approach, we don’t allocate specifically to higher risk areas of the bond markets such as emerging market debt or high yield, though it is possible our strategic bond managers may have some exposure within their funds.

A long term view

The shorter term has been painful for investors, but as always we point to the long term approach we adopt for investing. Once this crisis passes, dividends will resume, as soon as businesses are responsibly able to pay them.

In the meantime, companies that may have suspended dividends, but are quality businesses with a track record of dividend growth, are pricing attractively for our active managers to access for the first time in many years.

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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