With the end of low interest rates far from sight, the search for income has become all the more important for many investors. Unfortunately, at the same time the availability of equity income, a default choice for many, is at risk. Challenges such as these highlight the importance of diversifying sources of income in a portfolio and while alternatives exist, below we explore the option of higher yielding fixed income.

Dividend income: the investor’s source of choice

Equity dividends from FTSE 100 companies have long been a staple of many UK investors’ portfolios. For a large portion of these investors, the stability of dividend income, which fulfils roles such as generating cash and providing a boost to capital growth through reinvestment, has become a given. These roles have increased in importance in line with a growing expectation of “lower for longer” interest rates, which is compressing yields. 

Unfortunately for investors, UK dividend markets have been facing several headwinds for some time now. This is down to liquidity concerns and the concentration of dividends in the market, a challenging economic outlook and performance issues for some of the larger funds in the market. Despite this, the demand for equity income remains robust.

Given the economic shock this year caused by the coronavirus pandemic, the arguably already narrow pool of opportunities has diminished further. While value certainly remains in the market, recent dividend cuts and suspensions have been a stark reminder of the need to diversify income.

 

The coronavirus conundrum

While dividend cuts and suspensions are not unexpected in periods of economic duress, the reasons behind these failings are more complex than they may have been in the past. Rather than being directly related to fundamentals, this crisis has introduced political and social factors into the mix. As such, while we’ve seen recovery across all dividend markets, confidence is yet to be restored and performance remains weakened. As shown in the chart below, dividends across Europe have borne the brunt of the fallout.

A sharp drop in equity income
2020 dividend performance

Past results are not a guarantee of future results. For illustrative purposes. Investors cannot invest directly in an index.
As at 12 June 2020. Data shows the 2020 dividend futures for respective indices. Indices rebased to 31 May 2019. Source: Bloomberg

 

Across Europe, companies – particularly banks – are under varying degrees of government and regulatory pressure to suspend dividend payments. For example, at the end of March, the Prudential Regulation Authority (PRA), a financial services regulatory body for the UK, laid out its expectations for banks during the COVID-19 crisis. This included a cessation of dividend payments to protect their capital positions and having the ability to support the wider economy. At a broader level, some of the largest dividend payers may prioritise rebuilding balance sheets given the overall hit to the economy.

The nature of these dividend cuts, and the uncertainty of the global outlook, could introduce an added layer of volatility to dividend markets and lower the likelihood of a bounce back to previous yields once the storm is over. While this period has far from eliminated the value generated from equity income investments, it has highlighted the fragility of a portfolio that places “all its eggs in one basket”.  

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• The Prospectus and Key Investor Information Document set out risks, which, depending on the fund, may include risks associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.