Investing for income in 2020 has been anything but easy. Through the course of the year investors have faced dividend cuts, interest rates falling to an all-time low, market volatility, property fund suspensions and lower bond yields – all unfortunate repercussions of the Covid-19 pandemic.
It has been a particularly tough time for investors who rely on dividends from shares. As the outbreak of Covid-19 sparked national lockdowns, bringing some industries to a halt, companies sought to retain cash by cutting or cancelling their dividends. Since the start of the pandemic, close to half of FTSE 100 companies have reduced their payments.
Jake Moeller, a senior investment consultant at Square Mile, notes that 2020 highlighted the dangers associated with ‘concentration risk’ in the UK market: namely, the fact that the top 20 payers in the FTSE 100 traditionally accounted for around 80% of dividends.
Vaccine development a reason to be cheerful
So, after a torrid 2020, can income investors expect a brighter year ahead?
“Positive news on the Covid-19 vaccine development is a clear reason to be cheerful, with mankind’s ingenuity on show to crack the virus code in a matter of months rather than decades,” explained John Husselbee, head of multi-asset at Liontrust Asset Management.
The roll-out of a viable vaccine, which is now under way, will hopefully bring us one step closer to some form of normality and the prospect of a sustained economic recovery, providing a more stable backdrop for companies and consumers alike.
“Recent events have allowed investors to recalibrate their expectations for companies, a vaccine ‘floor’ if you will, creating more certainty around valuations,” Husselbee added.
Husselbee is bullish on the prospects for the UK market in 2021, pointing to the attractive valuations on offer and the fact that “there will be clarity on Brexit for the first time in more than four years, for good or ill”.
Nevertheless, the performance of markets and their underlying economies do not always move in tandem; Husselbee highlights the grim economic consequences associated with the pandemic, not least the Office for Budget Responsibility’s forecast that the UK economy will have contracted by 11.3% in 2020 – the biggest decline in more than three centuries.
While the vaccine roll-out brings hope that some dividends will resume in 2021, Brendan Gulston, co-manager of the LF Gresham House UK Micro Cap Income fund, says there is no getting away from the profound impact that Covid-19 has had on UK plc.
“We note the unpredictability of the virus and its impact on businesses and society, and therefore believe it is prudent to expect a varied picture for income-paying stocks next year,” he said.
Gulston anticipates an uneven pace of recovery across sectors. With this in mind, he says it is crucial to back quality businesses with sustainable income streams, which are well-positioned to tackle near-term challenges.
The fund manager cites Watkin Jones (LSE:WJG), a property developer and manager of student accommodation, as a good example. It has displayed resilience in spite of Covid-19 and continues to benefit from the undersupply of purpose-built student housing.
“Management took mitigating actions throughout the year to deliver robust financial performance and recently stated an intention to pay a full-year dividend for 2020,” he added.
Dividend stalwarts likely to be less generous payers
Square Mile’s Moeller suspects that a number of companies with robust business models and low debt levels should be able to maintain or even grow their dividend payments in 2021.
“As uncertainty around Covid-19 perhaps lessens in 2021, some companies with good free cash flow should be able to increase their payout ratios once again,” he said.
However, his optimism doesn’t extend to a number of traditional FTSE 100 dividend stalwarts, where he suspects there could be more permanent cuts to payments.
His favoured UK equity income funds include Trojan Income and Fidelity MoneyBuilder Dividend, which yield 3.6% and 5.8%, respectively.
Outside the UK, he says there is a strong case for holding international dividend-paying shares via global equity income funds. “Globally, companies have become much more disciplined in paying out dividends and the diversification benefits of this approach to equity income is considerable,” he explained.
His top income fund picks here include TB Evenlode Global Income and Janus Henderson Global Income fund, which yield 2.1% and 3.2%, respectively. Both funds aim to identify undervalued quality businesses around the world.
Meanwhile, Teodor Dilov, a fund analyst at interactive investor, highlights investment trust Murray International (LSE:MYI) as one to watch in 2021, with an attractive yield of 5%.
“While the trust’s portfolio is well-positioned to benefit from changes in sentiment towards cheaper stocks, it also offers an attractive ongoing charge [of 0.61%], which makes it an excellent value option,” he added.
Andrew Wilson, chief investment officer at Lockhart Capital Management, agrees that it makes sense to adopt a global approach to income investing in order to improve diversification. While yields from global dividend-paying stocks tend to be lower, he says they do offer potential for capital growth.
“International markets are developing their own reputation for strong dividend stocks, and so there is no real reason to be constrained by the UK,” he added.
Outside equities, Wilson expects to see slightly higher bond yields in 2021, as an economic recovery takes hold. “That said, yields are hardly attractive, relative to history, and even with inflation as low as it is,” he added.
For example, the 10-year UK government bond (gilt) yield stood at 0.21% in late December.
Moeller believes there are still selective opportunities in the corporate bond and high yield credit markets, but warns investors to be prepared for a potential increase in Covid-related defaults.
The hunt for yield in 2021
Beyond equities and bonds, some investors may be wondering where they can find an attractive and sustainable yield of 5% or higher.
Historically, commercial property funds would have been one of the first ports of call, with attractive yields on offer and the prospect of inflation protection owing to upward-only rent reviews. However, 2020 highlighted a number of issues in the sector. Over the spring, trading was suspended across more than 10 ‘open-ended’ commercial property funds after valuers said they could not accurately price the assets.
While some funds have since re-opened, investors are awaiting the conclusion of a review by the financial regulator. This could result in the introduction of a notice period between 90 and 180 days before investors can withdraw their money.
Fortunately, ‘closed-ended’ property funds, known as investment trusts, present another way to access commercial property, with specialist areas on offer such as healthcare and logistics. Here, Fergus Shaw, a portfolio manager at Cerno Capital, highlights Warehouse REIT (LSE:WHR) (which stands for real estate investment trust) as a good option. The portfolio focuses on multi-let industrial properties and counts warehouses as its tenants. It currently yields 5.4% and at the end of December was trading on a small premium of 0.6%, figures from Winterflood show.
“Warehouse REIT offers an attractive yield from a well-managed portfolio of industrial premises,” he added.
Husselbee also points to the potential income benefits associated with the infrastructure and renewable energy sectors.
“Unique to these is the fact that a significant amount of revenue benefits from stable and predictable demand, making them economically resilient. These defensive qualities are further supported by long-term inflation-linked contracted revenue streams, which are typically government backed,” he explained.
Moeller’s top pick in this space is the open-ended Legg Mason IF ClearBrdige Global Infrastracture Income fund. It yields around 5.2% and holds infrastructure companies across the world, focusing on themes such as power generation and toll roads.
Meanwhile, Shaw highlights Sequoia Economic Infrastructure Income (LSE:SEQI), an investment trust. It offers exposure to infrastructure debt across a number or jurisdictions and yields around 5.9%. It is, however, trading on a premium of 10%, which is higher than its 12-month average premium level of 5%.
Shaw also holds Hipgnosis Songs (LSE:SONG) within his TM Cerno Select fund, which is a multi-asset strategy. Although this investment trust doesn’t quite meet the 5% mark, with a yield of 4.3%, it does offer investors something completely different. Hipgnosis owns the rights to popular songs, such as Mariah Carey’s All I Want for Christmas is You. Over time, this should provide a utility-like income because a writer’s copyright on a song lasts for 70 years after their death. What’s more, it has a lower correlation to mainstream asset classes such as equities and bonds. The trust is trading on a small discount of 0.7%.
While 2020 has presented income investors with a host of challenges, the good news is there are still plenty of opportunities out there. Within equities, it makes sense to focus on quality businesses with sustainable income streams, both in the UK and abroad. Meanwhile, there are attractive yields on offer in so-called alternatives, such as property, infrastructure and music royalties. Hopefully, this should make for a brighter year ahead in 2021.
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