A dividend recovery took place in 2021. In 2022, should fund investors back their home market or take a global approach?
It has been an extraordinary year for income investors, following the trials and tribulations of 2020.
In stark contrast to the dividend cuts and cancellations last year, investors have benefited from a dividend recovery here in the UK and abroad, powered by the reopening of economies and the roll-out of Covid-19 vaccination programmes around the world.
In the UK, this recovery has been profound. During the third quarter, UK dividend payments totalled £34.9 billion, up some 89.2% from their 2020 lows, according to Link’s UK Dividend Monitor. The numbers were driven by a boom in mining dividends, which quadrupled year-on-year to £12.8 billion. There was also the resumption of payments from oil majors, such as BP (LSE:BP.) and Shell (LSE:RDSB), which benefited from a rebound in energy prices; and the return of banks to the dividend register (having been banned from making payments by the regulator in 2020). Unusually large one-off special dividends, totalling £7.2 billion, also provided a boost to investors.
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In light of these numbers, Link predicts that headline UK dividends are on course to total £93 billion in 2021, which represents an increase of close to 45% on 2020 – albeit still 16% below pre-pandemic levels. It will take time to recover from the unprecedented scale of cuts last year and it is not a surprise that a number of weak spots remain. For example, many UK airline, travel and leisure stocks are still unable to make payments.
Looking at the world at large, there were similarly upbeat headline figures during the third quarter. Janus Henderson recorded a 22% jump in global dividends to $403.5 billion (£302.9 billion), buoyed by a resurgence in underlying payments and strong growth in special dividends. In total, 90% of companies either raised their dividends or held them steady during the quarter, a much higher number than usual. The asset manager anticipates that global dividends should return to pre-pandemic levels by the end of this year.
So, as we look to 2022, where do the most attractive income prospects lie: at home or abroad?
Kamal Warraich, an investment analyst at Canaccord Genuity Wealth Management, suspects the UK’s dividend recovery will continue in 2022. He is particularly encouraged to see an improvement in the FTSE 100’s dividend cover ratio, which measures the number of times a company can pay dividends to its shareholders. On aggregate the FTSE 100’s dividend cover ratio has risen to two times, up from 1.6 times in 2019.
As a rule of thumb, a dividend cover ratio of around one times or lower suggests dividends are vulnerable, as the company is using most if not all its profits to fund the dividend. A figure of two or more is viewed as comfortable because it is a sign the business is not over-distributing.
“Bear in mind that many companies withheld dividends due to uncertainty in 2020, or because they were asked to by the regulator, not because they didn’t have the cash to pay them,” Warraich added.
UK income prospects
Kelly Prior, who forms part of the multi-manager team at BMO Global Asset Management, suspects there will be a ‘rich stream of opportunity for a tick-up in dividends’ both in the UK and abroad. But overall, she believes the domestic market has scope to recover the furthest.
Banks form a decent slug of the FTSE 100 and, although shareholders were hit by the regulator’s dividend ban last year, Prior is optimistic about their prospects in 2022.
Banks are emerging from the pandemic with strong balance sheets and have the potential to benefit from the Bank of England’s recent decision to raise interest rates from 0.1% to 0.25%, as well as any future interest rate rises. This is because they stand to make more money when interest rates are higher because they earn more in interest from loans and mortgages relative to what they pay out to customers.
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Prior also highlights rising inflation as a factor to consider. In November, UK inflation soared to 5.1%, its highest level in a decade on the back of rising energy prices and supply chain issues. Economically sensitive companies, which are typically classified as “value” stocks, make up a significant portion of the UK’s biggest dividend payers and Prior notes that these companies tend to perform better than their “growth” counterparts in an inflationary environment.
Nathan Sweeney, Marlborough’s deputy chief investment officer of multi-asset, said his firm had increased its allocation to UK companies on account of the attractive valuations on offer relative to other markets. “Investors have been steering clear of the UK for some years, with one of the reasons being the uncertainty around Brexit,” he said.
Sweeney added: “However, we’ve been seeing private equity houses snap up UK companies and that shows they see them as good value because stock market valuations here don’t look expensive. So, we believe the UK market could be one to watch in 2022.”
Marlborough currently has exposure via the iShares UK Dividend ETF (LSE:IUKD). This passive fund holds 50 companies that provide a higher yield than the FTSE 350 index.
There are, however, a number of drawbacks associated with the UK market, the most notable being the dominance of companies on the dividend register that are not considered environmentally friendly.
“Some investors may have doubts on environmental or ethical grounds about investing in a fund that holds companies such as Rio Tinto (LSE:RIO), Royal Dutch Shell (LSE:RDSB), BP (LSE:BP.) and British American Tobacco (LSE:BATS), which are among the biggest dividend payers in the UK stock market,” he explained.
This brings another issue to the fore: the high level of concentration in the UK market. Around 15 companies account for more than 60% of dividends paid in the UK today.
“This can result in disappointment if one of these giants runs into trouble unexpectedly,” Sweeney added.
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Global equity income funds, on the other hand, provide investors with better diversification as fund managers have a broader pool of companies to choose from. Investors can either opt for an actively managed global equity income fund or passive index fund or exchange-traded fund (ETF). Alternatively, investors could take a targeted approach by focusing on dividend-paying companies in a specific region, for example via a European equity income or Asian equity income active fund or an ETF.
Prior says there are income opportunities for those looking to take a global approach, but these can be nuanced.
“The global indices are dominated by the US, where income stocks are rare beasts. It has never been a rich hunting ground, with the market dominated by quality growth stocks that are more concerned with reinvesting their earnings or issuing share buybacks, rather than paying it out to their shareholders as dividends,” she explained.
“There are certainly opportunities in Europe and Asia however, and we have dedicated exposures in these markets where the opportunities are generally away from the big index names.”
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Warraich points out that, like in the UK, a large proportion of global dividends come from economically sensitive companies, so these stocks could be affected by any fallout from new Covid variants in the future.
He believes it is best for investors to take a ‘combined approach’ by holding both UK and global equity income funds in portfolios. In the UK, his team invests in the Threadneedle UK Equity Income fund, which protected its dividend well relative to the FTSE 100 and peers last year.
Abroad, Warraich likes the JPMorgan Global Growth & Income (LSE:JGGI) investment trust and highlights its strong returns over the past five years, not least during the pandemic.
“Investment trusts have a track record of preserving and even growing their dividends throughout major economic downturns. This is due to their ability to retain earnings and boost income in the more difficult years,” he concluded.
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