Covid-19: The income challenge

In the wake of economic lockdown, Alan Goodwin examines the outlook for dividend payments and explore how charities can seek to navigate the uncertain backdrop.

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Charities have faced income challenges in the past and will do so again. Recessions and economic slowdowns have generally offered alternative channels for income investors to navigate, and it has been possible to estimate and plan for the impact on income streams. The current challenges are unique in their nature; before even considering their investment income, many trustee bodies are facing temporary total loss of income from trading subsidiaries, fundraising events and the like. Prospects for a return to anything close to normality seem uncertain (at best).

In terms of investment income, the near-total economic lockdown has had a devastating impact on revenues for multiple sectors, creating an undeniably challenging outlook. Dividends from oil companies have been cut or appear under threat, while banks in many areas have been asked by regulators not to pay. A number of consumer-facing and industrial companies which are facing unprecedented falls in their revenue have moved to suspend or postpone their dividends. While for some it is a financial necessity to ensure sufficient cash for their operations, others are acting cautiously as they consider worst-case scenarios, or because they see it as important that all stakeholders share the pain while they receive government help. Income from property investments is as uncertain, and government bond yields have been driven to negligible levels.

Of course there are brighter spots. We would expect fixed-income coupons to continue largely uninterrupted, and some sectors (pharmaceuticals, some consumer stocks, and the technology and ‘online’ winners) remain in good dividend-paying health (although the technology sector tends to be quite low-yielding in the first instance).

Trustees should by now have a good grasp of the extent of their near-term investment income challenges, but how long will these challenges last? How quickly will companies return to dividend paying? Will they resume paying at historic levels? Or reset to lower distributions? In the absence of a material change in the course of the virus or firm news on vaccines, we may need to consider that the challenges described are perhaps starting to take on more of a ‘structural’ rather than temporary hue. Clearly the detriment will vary portfolio by portfolio, but we think that income reductions of around 30% for the calendar year 2020 will be quite typical from a balanced portfolio; we have little visibility now on how the situation will look in 2021.

How should we react?

In these difficult times, we are committed to doing what we believe is best for the long-term returns of charity investors. The current circumstances are naturally leading us to stress-test the companies in which we invest, but where they come through that process with our conviction unchanged, our first response will be to look through the temporary disruption to dividends to more normal times when dividends are resumed, and retain what we feel are good investments. This will suit many, but we recognise that what is best for each charity can be different. It is possible that some charities will require their portfolios to be managed with an emphasis on limiting the near-term income detriment. Others may be able to use capital to supplement income, or indeed may have some flexibility in their business through an income reserve, or the ability to defer some of their own expenditure.

A charity’s investment portfolio is, first and foremost, an integral part of the charity’s business, and needs to be configured appropriately to that end. Unfortunately, the current situation makes forward planning a significant challenge. As the remainder of 2020 unfolds, and information around the likely path to societal normality and therefore recovery becomes clearer, we will be working closely with investing trustees to plot the most appropriate course ahead.

Alan Goodwin is head of investment relationship management at Newton Investment Management, the sponsors of this article.

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