01 June 2020
GAM Investments’ Adrian Gosden and Chris Morrison discuss the outlook for dividends and explain why equity income investing still looks attractive compared to alternative sources of income.
The UK equity market has seen a plethora of dividend cuts and rights issues in the wake of the Covid-19 pandemic and associated economic shutdown. Many hotel and restaurant operators have been forced to suspend shareholder pay-outs and strengthen their balance sheets after being brought to a near standstill since March after the government ordered bars, restaurants and pubs to close. Banks and insurers have cut dividends after pressure from the government and regulators. House builders have announced dividend cancellations and deferrals to give themselves the best chance of navigating through the current disruption to their operations. Even oil majors, historically among the most generous and reliable dividend payers, are hoarding cash as the crude price collapse piles greater pressure on profits.
Clearly, the equity income model has come under pressure. However, when compared to alternative sources of yield, we believe equity income investing remains attractive. UK interest rates are at historically low levels and cash is yielding next to nothing. The UK government sold its first negative-yielding government bond on 20 May, meaning investors who hold the debt to maturity will get back less than they paid, when accounting for regular interest payments and the return of principal. In addition, the quality of the income from office buildings and retail outlets, which once appeared highly resilient, is coming into question.
Aside from implying a severely bad state of economic affairs, the events described above have a profound effect on markets. Consequences include rising pension deficits and a push by investors towards companies which can demonstrate growth. Growth stocks have performed far better than value stocks since March lows across markets and are outperforming significantly year-to-date. Indeed, the premium applied to growth has never been higher. We are not suggesting that is it wrong for investors to look for growth, however, in this extreme environment we see the economic downturn as an opportunity to own shares in good quality companies with cyclical earnings.
The pandemic has resulted in an economic decline which is bringing forward an inevitable end for some retailers and other business models that are structurally challenged. We therefore believe that holding companies in resilient sectors, regardless of whether they have cut their dividend, will prove beneficial. In our view, investors who understand liquidity and balance sheets, and support rights issues in the appropriate businesses, will be rewarded when taking a longer-term view.
Many shares, particularly in the mid and small-cap market, have not retraced since March lows. While in most cases we do not think earnings of 2019 will be repeated this year, we are optimistic that companies with the right business models to be back to 2019 earnings levels in 2021 / 2022. Similarly, while dividends have taken a hit in 2020, we believe that they should return within 12-24 months, albeit perhaps less generous in some cases. This is ultimately a call on the individual companies and their management teams.
Leaving aside the tragic loss of life, we ultimately believe the economic shape of the Covid-19 episode presents an opportunity for investors to buy and hold stocks at attractive levels and generate returns, particularly on a two-year timeline. Despite the harsh environment, we foresee dividends returning and continuing to be the most important driver of total equity returns over the long term. In the meantime, equity income investing looks likely to continue to prove beneficial for investors prepared to hold their nerve.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. Reference to a security is not a recommendation to buy or sell that security. June 2020