Interactive Investor

Why the outlook for dividends in 2023 has brightened

31st July 2023 12:10

by Kyle Caldwell from interactive investor

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For the first time in well over a decade, investing in equities is not the only way to obtain a high level of income. But the good news is that the outlook for 2023 has improved. Kyle Caldwell explains why. 

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The outlook for dividends has brightened due to banks paying out more dividends than expected, according to the latest widely followed Dividend Monitor report.

As a result, the forecast for dividends in 2023 has been upgraded. The report, formerly published by Link Group but now in the hands of global financial services company Computershare, now expects a year-on-year decline of 1.7% to £92.8 billion. Whereas, at the start of the year, dividends were expected to reach £91.7 billion, a 2.8% drop compared to 2022.

Underlying dividend growth, which strips out the more volatile special dividends, is now expected to rise by 6.1% to £88.9 billion. This is an upgrade of £2.7 billon compared to three months ago.

The improved forecasts are the result of a strong recovery in banking payouts, due to the sector being a beneficiary of higher interest rates. The banks “net interest margin”, which is the difference between the interest income they receive from making loans and the interest they pay out on deposits, increases when rates rise, which boosts profits and has led to higher dividend payments.

In the second quarter of 2023, banks made the biggest contribution to dividends, accounting for 61% of all those paid. The sector is expected to make the most significant contribution to dividend growth for the full year in 2023.

However, despite the outlook for the year brightening, in the second quarter UK dividends fell 9.0% to £32.8 billion on a headline basis, owing to lower one-off special dividends. Underlying growth was up 3.5%.

Computershare’s Mark Cleland says that outside the banking sector, companies with pricing power are proving resilient given the high inflation and elevated interest-rate backdrop.

In addition, Cleland notes that oil companies are holding up strongly and compensating for a decline in minding dividends. He adds: “UK companies collectively made record profits last year and have so far proved resilient in the face of interest rates, similar to their international peers, which has provided significant support for dividends and share buybacks.”

For the first time in well over a decade, investing in equities is not the only way to obtain a high level of income.

Cash-like investments, such as money market funds, are typically offering yields of 4% to 5%, while the types of bonds viewed as the lowest risk, such as gilts, are offering similar levels of income. Those who move further up the fixed-income risk spectrum will find higher yields. Bond yields across the board have been driven higher by interest rates rising notably over the past 18 months.

However, while bonds are certainly attractive again for income seekers, investors buying individual bonds today who are looking to hold them to maturity are currently accepting a below-inflation income return. In contrast, while there’s no guarantee, dividend-paying equities offer the prospect of inflation-beating returns through a combination of capital growth as well as dividend returns.

Cleland makes this very point. He says: “With UK government bond yields back at levels last seen 15 years ago and cash savings rates inching up in tandem, this big shift in the income landscape means equities now yield less than cash savings or bonds.

“It is important to remember, however, that dividends tend to grow over time, whereas bond coupons and cash interest do not, helping to tip the scales back in favour of equities as a long‑term investment, although they come with higher risks attached.”

Banking is a sector that UK equity income fund managers typically favour. Among them is Henry Dixon, manager of Man GLG Income, which is one of our Super 60 investment ideas. In a recent video interview, Dixon told us that when a mini-banking crisis played out earlier this year he used it as an opportunity to pick up more shares in HSBC (LSE:HSBA).

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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