When we put together a financial plan and a portfolio for a client, we structure them for the long term and create them with the goals and aspirations of the individual in mind. However, as the coronavirus continues to make its presence felt in markets, investors and their advisers will continue to monitor the impact the volatility is having on their portfolios.
We have many clients who seek to generate an income from their portfolios. In the current climate, as global equities struggle with the economic shock of the Covid-19 pandemic, dividends have come under pressure. It’s difficult to predict the future and estimate the full extent of the economic impact but we must be realistic and acknowledge that earnings and dividends are likely to remain vulnerable.
So, what has our response been to this at Progeny? First, we went through our stocks and assessed what we believed to be their ability to pay dividends, assigning our own expected yields. Key questions included: are yields sustainable? Is the company geared? Is the dividend covered? Does the company have cash flow and how has it navigated previous crises?
Then, as companies began to send out updates to investors on the impact of Covid-19, we evolved a simple organising principle to classify dividend cuts. We assigned them to specific buckets according to the cause of the dividend cut in each instance. Our three distinct buckets are:
- The distressed: businesses which are facing operational challenges, e.g. leisure sector.
- The mandated: cancellations resulting from political, or regulatory pressure, e.g. the banking sector.
- The prudent: companies that have omitted dividends due to lack of visibility.
This also allows us to make a judgment as to whether a dividend has been cancelled or deferred, which is key to deciding whether to add, hold or sell an investment.
From principle to practice
How do we act on these findings? We start with the distressed bucket, which is the most straightforward: these are the stocks we sell. That said, we have nevertheless had to make some tough decisions in the last few months as companies we held which we considered strong with good growth and income prospects have had their whole business models turned upside-down overnight.
For the companies in the mandated bucket, we revisit our process to see if the dividend was strong and assess whether this is now just a delayed prospect until 2021. Unlike the financial crisis in 2008, when the dividend tap was turned off by poorly capitalised banks, this time round it is the regulator which has asked the financial sector to withdraw payments.
For the companies in the prudent bucket there is no one single, clear answer on whether we should add, hold or sell. Whilst the cessation of dividends can be disappointing, it may in some cases be in the best interests of shareholders. For some companies it may help reset the dividend pay-outs to more palatable levels, or it may simply strengthen a balance sheet to give management more fire power to capitalise on opportunities which may have arisen due to the unprecedented circumstances.
For the time being, we believe categorising companies in this way provides a useful rule of thumb. Despite living through some of the most challenging and unexpected trading circumstances in recent memory, recovery is likely for many businesses. The question for investors is likely to be how long they are prepared to wait. The common theme of many current financial statements is one of a lack of visibility, but once this returns, we expect clear direction and decisions to be made. In the meantime, we are working hard to maintain the best possible yield for income-seeking clients, but we will not compromise quality solely for yield.
In summary, it is important for all parties to engage with each other, be that companies speaking to their shareholders or investment managers to their clients. We have been talking and communicating constantly with our clients and their advisers throughout.
As always, our aim is to understand our clients’ individual circumstances, what they want from their investments versus what they need, and how the current climate might be impacting their aspirations – while at the same time retaining an overview on how this all fits into the bigger picture of their longer-term financial goals.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and the value of investments can fall as well as rise.