Dividends have always been an important part of the total return a shareholder receives on their investment.
Given the low-to-no growth environment of the past decade, payouts have become increasingly significant in determining share prices.
So as dividends and buybacks are cut and withdrawn, what might the lessons be for clients seeking income?
In the UK, combined annual dividend payouts grew at an average of 7.3 per cent between 2010 and 2019, a cumulative increase from £54.6bn to £110.5bn.
This rise has carried share price growth with it despite challenging economic conditions, providing income-seekers with a rising natural yield from their portfolios as well as growing the capital value of their investments.
But that positive trend has changed radically with the coronavirus crisis and, as a result, dividends are facing a significant headwind.
Almost half of UK companies had cut or suspended payouts by early April, with the most optimistic forecasts suggesting total UK payouts could fall 27 per cent from 2019’s total.
According to the latest UK dividend monitor report from financial data provider Link Group, a worst-case scenario could see total UK dividends fall more than 50 per cent.
More conservative estimates put expected losses to shareholders between 32 and 39 per cent on last year’s payouts.
Don’t bank on the banks
The biggest loss in the UK is likely to come from the banking sector, the country’s second largest payer of dividends.
Banks collectively agreed to cancel dividend payments for the rest of this year, amounting to more than £13.5bn in lost income for shareholders.
The Prudential Regulation Authority has welcomed the decision and requested any outstanding dividends from 2019 also be suspended.
The largest paying sector of the UK economy in recent years has been energy.
Oil companies form a significant chunk of that group, and were already in the midst of a production battle between the world’s largest exporters before the consequences of Covid-19 were truly felt.
The industry’s supply and demand dynamics have taken an unprecedented shock, which saw the price of a barrel dip into negative territory on 20 April.
This damage is starting to be passed on to shareholders. For the first time since World War II, British-Dutch group Shell announced at the end of April it would be cutting its first quarter dividend to weather the impact of the Covid-19 crisis.
The industry isn't under the same political pressure to withhold shareholder payouts though, and UK-based BP maintained its dividend for the first quarter, despite seeing profits plunge by two-thirds during the period.
The global dimension
So what does this mean for clients, and what lessons can they learn to protect their portfolios in the future?
In our view, one part of the answer is a globally diversified portfolio.
Income-seeking portfolios with a strong bias to the UK could be missing out on international income from regions where regulations and customs are different and payouts will be less affected.
For example, financial companies in the US are not under any obligation to withhold dividends, while parts of Asia may be better equipped to maintain dividend payments.
Source: Factset, Vanguard. Notes: Based on MSCI Gross Total return indices in local currency from 31/12/2019 to 11/05/2020
As the table above shows, the different regulatory and economic conditions are reflected in the total returns of regional equity indices between 1 January and 11 May 2020.
UK (-20.8 per cent) and European stocks (-16 per cent) suffered more than the US (-8.2 per cent), Japan (-12.7 per cent) and the broader Asian market (-9.2 per cent).
In other words, the hit to a globally balanced portfolio may be cushioned and less sensitive to regional shocks.
The question of total return
The other part of the answer might be for income-seeking investors to consider the benefits of targeting total return, rather than natural yield from their investments.
One of the main advantages of total return strategies is the broader universe of stocks to choose from when dividends are not the fundamental criteria.
A greater range of securities in a portfolio also helps dampen volatility by spreading risk.
Income-driven strategies tend to display a significant bias towards value stocks, which often means the portfolio is highly exposed to a handful of stocks that pay an attractive dividend.
If those stocks cut or suspend their dividends, the portfolio suffers and the income may fall below an investor’s spending requirements.
There is also greater flexibility when it comes to withdrawals.
By targeting total return and thereby growing the value of the portfolio at a faster rate, investors can supplement portfolio income with capital growth to fund withdrawals.
This can be useful when income from dividends falls below the required spending amount.
It's worth remember that capital not paid out as dividends can be used to support the business during a crisis.
This is the case with many companies now. It can also be reinvested to increase the company’s share price in future.
That may not be as relevant in the case of banks in the response to the current pandemic, as they are obligated to support the wider economy. Nevertheless, broadly speaking, a little patience and discipline can bring long-term rewards.
After all that, all investors can do is remain patient for more certainty to emerge around earnings and dividends.