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Dividend Update: How we managed to minimise dividend cuts in our dividend strategy

29 October 2020
But when the pandemic exploded in March it was a whole new ball game. While airlines and tourism-related firms were particularly badly hit, companies across sectors suffered in the lockdown and were forced to cut their dividends.
Even some firms that weren’t struggling did so. Some regulators in Europe asked banks to postpone paying a dividend until later in the year, while others went further and explicitly told banks not to pay out. They even banned some insurance companies – some of which were actually profiting from the lockdown because they were paying out fewer claims (for example, because there were fewer cars on the road, which meant fewer accidents) – from making payouts. In the US, it was a bit less draconian, with firms allowed to pay a dividend if they met certain requirements.

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Extraordinary times, extraordinary measures

We take dividend sustainability very seriously. We look at what we call the “risk trinity” for every company: its business risk (whether it’s in a cyclical industry or growing steadily), financial risk (the amount of debt on the balance sheet) and ESG risk to help us understand if there are potential issues for the firm down the line. We can’t avoid every dividend cut, but this really helps us keep them to a minimum.

In normal times, we only invest in firms with an expected 12-month dividend payment above 3%. But during the pandemic we realised that if we followed that rule, we’d have to sell a significant number of our holdings – which were cheap, highly attractive investments – just because a virus outbreak had caused them to temporarily halt their payments. We didn’t believe this was in the best interest of our investors. 

With this in mind, we developed a framework to work out which companies we should continue to hold. To remain in our portfolio, they had to pass four criteria:

  • they should be in a sector that had been affected by coronavirus but had the potential to recover
  • they should have only stopped paying a dividend temporarily as an act of prudence
  • they should still have strong long-term earnings power and a long track record of paying dividends
  • they should be well positioned within their sector, both operationally and financially. 

So, for example, apparel firm H&M met all four of these requirements so we continued to hold it. Lloyds Bank, however, only met three (we don’t see it as one of the best-positioned banks), so we sold it. We were subsequently rewarded as H&M recovered strongly. 

The upshot of our approach was that the dividends we received fell by just 13%: 32 holdings cut their dividend and 48 holdings actually increased how much they paid out. This is the benefit of a global diversified portfolio – we invest across regions and sectors, and there were fewer dividend cuts in the US and Asia than in Europe. Our global strategy is also 150bp ahead of the Morningstar universe of firms paying out at least 3% so far this year.

An optimistic outlook
There’s no denying it’s been a hard time for dividend investors this year, but we’re optimistic about the potential for dividend growth next year. We expect over 50 of our portfolio holdings to increase their dividend next year, mainly because banks will start paying dividends again from the start of 2021.  We realise the importance of this income for our investors, and it continues to act as an appealing complement to our attractively valued current portfolio.

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