Income investing in a pandemic – finding a way throughCharles Luke, Investment Director, UK Equities, Aberdeen Standard Investments
As a consequence of the global pandemic, we currently find ourselves in unchartered waters. Daily life has been altered beyond recognition for many of us and will likely remain that way for some time to come. It’s unfamiliar territory for investors too, as we grapple with the effects of the wide-scale lockdown on companies, economies and financial markets.
For income investors in particular, the environment is completely unprecedented. In the UK, 43 of the FTSE’s 100 companies have cancelled, cut or suspended their dividend payments. That includes major UK companies that have previously been considered totems of dividend security.
Companies have taken these actions for a variety reasons. Banks and insurers face regulatory pressures and have been told by the Bank of England’s Prudential Regulatory Authority not to pay dividends. Other companies have taken government assistance during the pandemic and so have refrained from paying shareholders for fear of bad press. For several businesses though, it’s about taking a cautious approach and preserving cash when the economic outlook remains so opaque.
This backdrop is obviously important to income investors, given the significance of dividends and dividend growth for investment returns. We were already dealing with a world of low growth, low interest rates and low inflation. Then the pandemic came along and added to these pressures. This year, income is expected to be 40-50% lower than 2019. So what kind of investment approach might help income investors navigate this new terrain?
Income investing hasn’t had the most positive press recently, with the collapse of a high-profile fund and other scandals. We have always maintained that income investing should never be about chasing high yields. Rather, it should be about long-term quality and sustainability. And it’s at times like these, when corporate distress is high, that such an approach can prove its mettle.
We look for dependable high-quality companies with strong balance sheets, which enable them to continue to grow their business, reinvest in it, perhaps partake in M&A, and grow their earnings year on year. These quality businesses are more likely to be able to pay dividends, even when conditions change or are challenging. Similarly, we focus on companies with compelling long-term structural growth stories, perhaps with global brands or valuable intellectual property. In the current environment, some of the strongest companies should be able to grow stronger.
Dare to diversify
The pandemic has and will continue to affect different companies and sectors in different ways and at different times. As always, it makes sense to be well diversified and not overly dependent on any one economic scenario, sector or company.
Dispersion across mid-cap and large-cap stocks can be a good idea too, as can exposure to other types of investments. For example, we have the ability to write options in some of our UK equity funds, which can provide a valuable uncorrelated income stream.
Know your companies
Company fundamentals matter, now more than ever, and it pays to know investee firms inside and out. Understanding their business models, believing in their management teams and recognising their competitive advantages can help manage investment risk.
How a company deals with the environmental, social and governance (ESG) aspects of its operations can also be a sign of quality. ESG considerations are embedded in the investment process at Aberdeen Standard Investments. That’s because we believe companies that behave responsibly and look after their ESG issues are more likely to deliver sustainable investment returns and better outcomes for all. A rigorous ESG approach fits ‘hand in glove’ with our quality-income focus.
A combination of in-depth proprietary research, experienced investment teams and ESG specialists can really show its worth, especially during a crisis. It can help get to the heart of a company’s dynamics and identify what might be changing in its business. Augmenting this with the views of independent experts and first-hand insights from meeting with company management can reveal the ‘full picture’ of an investment. While the right conclusions are not always drawn, identifying an improvement in a company before the market does can lead to healthy gains.
We prefer to maintain a laser focus on quality companies that we believe can stay the distance.
In situations like now, there is always a strong temptation to churn portfolios and react to short-term newsflow and noise. But it’s exactly at points like these that it’s important to keep focused on the long term and maintain a conservative approach.
There’s also the ‘siren call’ of investing in lower-quality companies with better near-term dividends. However, we believe that approach seldom works. In our opinion, there is never a right time to buy low-quality higher-yielding companies for their dividends. Instead, we prefer to maintain a laser focus on quality companies that we believe can stay the distance. At the same time, we remain vigilant to the downside risks and the upside opportunities that will arise as we navigate these uncertain times.
Issued by Aberdeen Standard Investments
The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested. Before investing, investors should consider carefully the investment objective, risks, charges, and expenses of a fund. This and other important information is contained in the prospectus and KIID document. The information is intended to be of general interest only and should not be considered as an offer, investment recommendation or solicitation, to deal in the shares of any securities or financial instruments.