Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

The recovery in stock markets since the pandemic-induced crash at the start of this year has meant shareholders have been spared the worst effects of Covid-19.

But in one area, the pain has been very deep indeed. Dividends have been a notable casualty in the crisis so far, making life difficult for those who rely on the pay-outs for regular income.

There was more evidence of the bonfire of dividends today in data which suggest UK dividends overall were 57.2% lower in the second quarter of 2020 than the same period last year. That includes many special dividends, but even excluding those the effect on regular payments has been deep, with underlying dividends falling 50.2%.

The falls were revealed in the latest UK Dividend Monitor report from Link Asset Services. It showed that Covid-related cuts to dividends now exceed the previous nadir, which occurred during the financial crisis. In the aftermath of the global financial crash the worst quarter in 2009 saw two fifths of companies cut their dividends, and only half of those cancelled them altogether. This time, 176 companies have cancelled their dividends altogether and another 30 have cut them, making up three quarters of all the companies that usually pay in the second quarter. Just 61 increased their pay-outs.

Of the £16.4bn of cuts in underlying dividends in the second quarter, half of the impact came from the financial sector after the Bank of England told banks to cancel all shareholder pay-outs for 2020. Insurers, too, have been under pressure to cut.

The biggest single blow came when Shell cut its giant payment by two-thirds, the first reduction it has made since the Second World War. Oil-sector cuts totalled £2.2bn in the second quarter with almost as much, £2bn, coming from the wider industrials sector including aviation, construction, engineering, and support services. Another £1.7bn has been cut from the dividends of consumer discretionary sectors that include media, housebuilding, travel and leisure. Only four companies out of 55 did not cancel their second quarter pay-out.

Share prices for dividend paying companies have moved lower to reflect the diminished outlook. This has the effect of making the yields available from them appear back to something like normal levels. As such, Link predicted that UK equities would yield 3.6% on a best-case scenario over the next 12 months, which is broadly in line with the long run average of 3.5%, or 3.3% on a worst-case scenario.

These predictions, of course, come with a heavy dose of uncertainty. Some companies have cut dividends out of stark necessity - their trading has been seriously affected and may not return quickly. Others have cut because they have been instructed to (in the case of banks) or as a precaution while lockdown conditions persist. Those taking furlough support from the Government, for example, may not feel it is reputationally possible to pay shareholders while benefitting from state largesse.

All this makes investing for dividend income an even bigger challenge than it usually is, and ordinary investors may struggle to correctly identify the temporary dividend cuts from the permanent ones.

This is the expertise of the equity income fund managers, who assesses not just headline income levels but also the robustness of dividend payments. They are looking not just for good income now, but sustainable income in the future.

Our Select 50 list of favourite funds includes several which invest to derive an income from shares. Invesco Global Equity Income invests around the world, so income is diversified by region. The majority of the fund is made up of Dividend Compounders: companies that have a strong track record of paying and growing dividends; The remainder is made up of low yielding, but faster growth stocks: those companies with good capital allocation, resulting in compelling returns on invested capital.

Franklin UK Equity Income focuses on British companies. It’s two biggest positions right now are in pharmaceutical giants AstraZeneca and GlaxoSmithKline.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered

Investing for incomeUKVolatility

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