Square Mile Update

13 August 2020

By Jake Moeller, Senior Investment Consultant, and Andrew Johnston, Portfolio Manager Square Mile

Most investors will be familiar with the power of dividends: £100 invested in the FTSE 100 in 2010 would be worth £111 today. With dividends, this £100 would be worth £166. So dividends represent 33% of the total return over this time period. Turning to the US, the figure for the S&P 500 is slightly lower: $100 invested in 2010 is worth $371 today, rising to $433 if dividends are included, with this component representing about 14% of the total return over this period. Within both of these markets these percentages increase over longer time periods and can be as high as 90% in some instances.

Concentration risk in the FTSE 100 is a very real phenomenon which most of us will be aware of. The top 20 dividend payers in the FTSE 100 account for over 80% of total payments with the top six being responsible for over 50%. However, the Covid-19 outbreak has led to a number of dividend cuts, notably amongst the banks, and since the start of the Covid-19 crisis over a third of the companies within the FTSE 100 have reduced or cancelled dividend payments. This is a remarkable figure because typically it is corporate earnings, not dividends that absorb the hit during difficult times. If the dividend yield on the FTSE 100 has halved (as it has for the year to date compared to 2019), then that compounding factor is weakened, reducing that component of dividend returns in future. This could potentially be problematic for investors.

We are very aware of the dividend headwinds impeding the future returns from many companies and have acted to lesson the impact this might have on our portfolios. The UK stock market is one of the worst affected given the number of financials and commodity-related businesses that go to make up the FTSE 100. But this, along with our view that Brexit risks firmly remain even if it is a story that has been relegated to the back pages more recently, is one of the reasons why we have less invested in the UK stock market than we historically would. This provides some natural protection from this year’s fall in dividends in the UK across the portfolios.

While it is hard to escape the full impact of dividend cuts on a global scale, we have ensured that the portfolios are well diversified and not all regions or even industries have been affected equally. We hold investments in a range of strategies that are able to provide an element of shelter from these dividend cuts. This includes infrastructure, for example, where companies such as utility firms are less exposed to what happens in the broader economy and so are able to continue to provide fairly reliable income streams. We also hold many strategies that focus on investing in growing businesses where growth in profits, not dividends, are the main driver of a stock’s investment return.

The portfolios are also well diversified in areas outside of equities such as fixed income. Fixed income assets represent a contractual obligation to pay interest and repay a loan. Whilst there will be companies that unfortunately go bust in the current climate and therefore will default on their debt, we believe the managers of the funds that we hold in the portfolios have the necessary skills to avoid most of these.

So overall, while widespread dividend cuts do impact the returns of many companies, by ensuring the portfolios are well-diversified both across equities and through holdings in other sectors, future returns are not wholly reliant on this one element.

The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. The contents of this article should not be construed as advice and is for information only. Individual stock selection should only be performed by suitably qualified advisers.