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.
2020 was an historically challenging year for anyone relying on a dividend income. Who can forget the seminal moment last March when the UK regulator directed banks to cancel dividends and staff bonuses, a step that would have been considered unthinkable before the 2008 financial crisis? Or Royal Dutch Shell’s decision a month after that to cut its dividend for the first time since World War II?
Many other large companies followed that lead with dividend cuts or suspensions that could be classed as necessary, precautionary, politically expedient or a chance to rebase a dividend that had become a bit of a stretch or any combination of all of these. In aggregate, dividend payments fell by around 38% last year, with businesses in the financials and oil sectors accounting for three fifths of the cuts1.
The pendulum began to swing the other way early last August, when UK companies including the paper packaging business Mondi and insurer Aviva reversed decisions to suspend their 2019 final dividends in view of the pandemic’s limited impact on profits and less uncertainty in their outlooks2.
In the first quarter of this year, 12 FTSE 100 firms returned to the dividend list3. Company results so far this month from some of Britain’s largest dividend payers have fuelled hopes of a further income rebound.
The oil majors BP and Royal Dutch Shell blew first quarter profit expectations out of the water last week, after months of oil prices back at pre-pandemic levels. Shell raised its quarterly dividend by 4% – a drop in the ocean compared with a two-thirds cut this time last year – but reduced its net debt by just over US$4 billion over the quarter. Shell aims to distribute 20% to 30% of its cash flows from operations via dividends or share buybacks, once its net debt falls to US$65 billion (currently US$71 billion)4.
BP reduced its net debt even faster than Shell in the first quarter, by US$5.6 billion, and to below its US$35 billion target. The company said last week it would now retire this goal and resume share buybacks, while holding dividends at their current level for now. BP cut its dividend by a half last year, but its shares still have a respectable yield of 5%5.
Profits at HSBC surged 79% in the first quarter compared with the same three months a year ago, as lending increased and an improving outlook for the UK and world economies allowed the bank to reduce its reserves for loan losses. While a final dividend for 2020 was announced back in February, the return of a quarterly dividend remains off the agenda for now. The bank said it would consider announcing an interim payment with its half-year results in August6.
Some sectors escaped relatively unscathed last year, with large companies in the consumer staples sectors – including Diageo and Unilever – proving to be among the most resilient. Some of Britain’s largest mining companies – BHP and Rio Tinto – have already announced they will be paying record dividends in 2021, after a buoyant year for commodities7.
Consumer sectors hard hit by the pandemic – including leisure and retail – will undoubtedly take longer to rescale such heights, especially if the events of the past year have laid bare structural deficiencies, for example, a vulnerability to customers moving online. Moreover, Link – the author of “UK Dividend Monitor” doesn’t expect UK dividends in aggregate to return to their previous best levels until 2025 at the earliest8.
However, while painful over the short term, dividend cuts have arguably made some companies stronger, more able to sustain payouts in the future and with more cash left over to reinvest in their businesses. As it stands, the FTSE All-Share Index yields a little less than 3%9.
The stock market’s yield is likely to remain difficult to forecast with any degree of accuracy over the months to come, as further companies return to the dividend register or make ad-hoc payments in the event their businesses were not as adversely affected by the pandemic as first thought or as their business outlooks brighten.
The bottom line though is that UK equities remain an attractive source of income in a low interest-rate world and a potential source of some capital growth, which should translate to a higher income earning capacity over time.
Owning investments that generate dividends makes a good deal of sense in an environment where the economy is growing, corporate profits are rising and inflationary pressures are building. Inflation reduces the buying power of the fixed income payments that bond issuers make, whereas rising corporate profits make more room for businesses to pay higher dividends.
UK equity income funds additionally have the great advantages of diversification and the flexibility to steer round companies with temporarily or permanently compromised dividend strategies.
Investors can currently expect to see straightforward UK equity income funds with published yields of around 3.5% to 5%, or yields a bit higher than this for funds that also invest a proportion of their assets in high yield corporate bonds or use financial derivatives to boost their income streams. Investors should be aware, however, that higher incomes derived from either of these two strategies generally limit the ability of funds to also generate long term capital growth and/or a rising income. Investors should also note these yields will fluctuate and are not guaranteed.
Fidelity’s Select 50 list features high quality equity income funds offering attractive yields and the potential to produce an income that grows over time.
The actively managed Franklin UK Equity Income Fund benefits from a four-strong management team based in Leeds. Among the Fund’s 47 current investments are large holdings in Unilever, AstraZeneca, Rio Tinto and Legal & General. The Fund pays a quarterly dividend and currently yields 4%.
Unsurprisingly, the Fidelity Global Dividend Fund has a wider investing remit and a flexibility to invest in sectors and industries underrepresented in the UK, including technology. As such, the Fund offers diversification benefits to investors with largely UK based portfolios. Current large holdings include Taiwan Semiconductor, Unilever, Novartis and Samsung Electronics. The Fund currently yields 2.5%.
1,8 Link Group, 20.01.21
2 Mondi and Aviva, 06.08.20
3 AJ Bell Dividend Dashboard, Q1 2021
4 Royal Dutch Shell, 29.04.21
5 BP, 27.04.21, and Bloomberg, 29.04.21
6 HSBC, 29.04.21
7 BHP, 16.02.21 and Rio Tinto, 26.02.21
9 FTSE Russell, 31.03.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Yields quoted will fluctuate and are not guaranteed. 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. Select 50 is not a personal recommendation to buy or sell a fund. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. The Franklin UK Equity Fund and Fidelity Global Dividend Fund invest in a relatively small number of companies so may carry more risk than funds that are more diversified. Both funds use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The Fidelity Global Dividend Fund uses currency hedging to substantially reduce the effect of currency exchange rate fluctuations on undesired currency exposures. There can be no assurance that the currency hedging employed will be successful. Hedging also has the effect of limiting the potential for currency gains to be made. 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 a Fidelity adviser or an authorised financial adviser of your choice.
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