For income investors in particular, the environment is completely unprecedented. In the UK, 43 of the FTSE’s 100 companies have cancelled, cut or suspended their dividend payments. That includes major UK companies that have previously been considered totems of dividend security.
Companies have taken these actions for a variety reasons. Banks and insurers face regulatory pressures, and have been told by the Bank of England’s Prudential Regulatory Authority not to pay dividends. Others companies have taken government assistance during the pandemic and so have refrained from paying shareholders for fear of bad press. For a number of businesses though, it is about taking a cautious approach and preserving cash when the economic outlook remains so opaque.
This backdrop is obviously important to income investors, given the significance of dividends and dividend growth for investment returns. We were already dealing with a world of low growth, low interest rates and low inflation. Then the pandemic came along and added to these pressures. This year, income is expected to be 40-50 percent lower than 2019. So what kind of investment approach might help income investors navigate this new terrain?
Income investing has not had the most positive press recently, with the collapse of a high-profile fund and other scandals. We have always maintained that income investing should never be about chasing high yields. Rather, it should be about long-term quality and sustainability. And it is at times like these, when corporate distress is high, that such an approach can prove its mettle.
We look for dependable high-quality companies with strong balance sheets, which enable them to continue to grow their business, reinvest in it, perhaps partake in M&A, and grow their earnings year on year. These quality businesses are more likely to be able to pay dividends, even when conditions change or are challenging. Similarly, we focus on companies with compelling long-term structural growth stories, perhaps with global brands or valuable intellectual property. In the current environment, some of the strongest companies should be able to grow stronger.
Dare to diversify
The pandemic has and will continue to affect different companies and sectors in different ways and at different times. As always, it makes sense to be well diversified and not overly dependent on any one economic scenario, sector or company.
Dispersion across mid-cap and large-cap stocks can be a good idea too, as can exposure to other types of investments. For example, we have the ability to write options with Murray Income Trust, which can provide a valuable uncorrelated income stream.
Know your companies
Company fundamentals matter, now more than ever, and it pays to know investee firms inside and out. Understanding their business models, believing in their management teams and recognising their competitive advantages can help manage investment risk.
How a company deals with the environmental, social and governance (ESG) aspects of its operations can also be a sign of quality. ESG considerations are embedded in the investment process at Aberdeen Standard Investments. That’s because we believe companies that behave responsibly and look after their ESG issues are more likely to deliver sustainable investment returns and better outcomes for all. A rigorous ESG approach fits “hand in glove” with our quality-income focus.
A combination of in-depth proprietary research, experienced investment teams and ESG specialists can really show its worth, especially during a crisis. It can help get to the heart of a company’s dynamics and identify what might be changing in its business. Augmenting this with the views of independent experts and first-hand insights from meeting with company management can reveal the “full picture” of an investment. While the right conclusions are not always drawn, identifying an improvement in a company before the market does can lead to healthy gains.
In situations like now, there is always a strong temptation to churn portfolios and react to short-term newsflow and noise. But it’s exactly at points like these that it’s important to keep focused on the long term and maintain a conservative approach.
There is also the “siren call” of investing in lower-quality companies with better near-term dividends. However, we believe that approach seldom works. In our opinion, there is never a right time to buy low-quality higher-yielding companies for their dividends. Instead, we prefer to maintain a laser focus on quality companies that we believe can stay the distance. At the same time, we remain vigilant to the downside risks and the upside opportunities that will arise as we navigate these uncertain times.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ.
Risk factors you should consider prior to investing:
– The value of investments and the income from them can fall and investors may get back less than the amount invested.
– Past performance is not a guide to future results.
– Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
– The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
– The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
– The Company may charge expenses to capital which may erode the capital value of the investment.
– Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
– There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
– As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
– Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
Charles Luke is investment manager at Murray Income Trust PLC.
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