How to replace lost dividend income

A couple of weeks ago, when the UK stock market was yielding 6%, we asked if that rate was sustainable, given the number of companies announcing dividend cuts.

Having looked today, it obviously wasn’t - the yield has fallen to 4.9%* and is likely to fall further, as more companies look to keep hold of whatever cash they have, to help them through these very difficult times.

First the bad news

Link Asset Services has said its worst-case scenario is that total UK dividends could fall by 50%** - so investors could potentially see their income halve in value.

Our own research team’s analysis suggests nearly all equity income funds will also see their dividends fall as a result.

The other bit of bad news is that this is happening all over the world - it's not just a UK problem, although our concentration of dividend payers is probably more marked.

Banks, energy and commodities companies represent more than half (56%) of UK dividends***. The banks have obviously been told not to pay dividends, and oil and gas companies have their own problems with the oil price war (although talks have started again).

Now the good news

The good news is that all of the fund managers we have spoken to so far believe this will be a temporary problem – a ‘dividend sabbatical’, if you will. Companies that have suspended, rather than cancelled payments, will look to return this money to shareholders.

And not all companies will stop paying dividends or even reduce them - the supermarkets for example, are in a good place, as are most utilities firms and pharmaceuticals. So, some sectors will do better than others.

How can investors replace this lost income?

Those investing in funds may like to opt for a multi-cap fund like LF Gresham UK Multi Cap Income, or Montanaro UK Income. Neither will be immune to dividend cuts, but they are also less reliant on the UK's largest companies and the sector concentration mentioned above. The manager of Montanaro fund, for example, has suggested its 4.7% current yield could be impacted by around a third of holdings cutting or cancelling their dividends.

If investors want to go overseas for added diversification, they could consider TB Evenlode Global Income or Guinness Global Equity Income. The latter started the year with no exposure to banks, travel companies, hotels, airlines or restaurants – the areas of the market hit the hardest – and has a focus on companies with the strongest balance sheets. The managers expect some holdings to suspend or delay dividend payments, but far less than the wider market.

Looking to other asset classes

Another option would be to invest in other asset classes – bonds for example. While dividends are discretionary, bond interest – the coupon – is contractual, so must be paid unless the firm goes bust.

As we mentioned recently, a number of managers from the Chelsea Selection, including those running the Artemis Corporate Bond, BlackRock Corporate Bond and TwentyFour Corporate Bond funds, believe this could be an opportune time to invest – both from a capital growth and income perspective.

And, of course, there are always multi-asset funds. Again, they will be immune from dividend cuts as they do, by definition, also invest in companies or other funds paying dividends. But they are very diversified and should see their income fall by a smaller amount.

For example, the investment advisors of the VT Chelsea Managed Monthly Income fund believe the current level of income is secure for approximately three months.

For more information about this fund and the others in the VT Chelsea Managed range, click here.

*As at 20 April 2020

**Source: Link Asset Services Q1 dividend monitor report

***Source: Montanaro, 31 March 2020

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and do not constitute financial advice.

Published on 20/04/2020