Income fund managers have struggled this year amid a deluge of dividend cuts. Shell (RDSB), BT (BT.) and Imperial Tobacco (IMB) are among many big UK dividend payers to have cut or suspended income payouts. Under a worst-case scenario, total income worldwide could plunge by around $500 billion this year, according to Janus Henderson.
In April we spoke to managers of open-ended funds about how they are navigating the income crisis. Now we have asked the managers of three investment trusts where they are looking for yield in these uncertain times for income investors.
Closed-end funds have an advantage over open-ended funds because rules allow them to keep 15% of income in reserve every year to cope with fallow times, whereas funds must pay out all income received to investors. This should mean they can still pay out during difficult times, but managers still face the same issues of finding enough income to guarantee future dividends for investors.
Don’t Neglect Commodities
Energy firms have been in the eye of the storm this year as global lockdown measures have crushed demand for oil and other commodities. Oil prices briefly went negative in April as traders rushed to ditch unwanted futures contracts. While crude has recovered since to around $40 a barrel, oil giants such as Shell and Exxon (XOM) are expecting a bruising year for revenues. BP (BP.) hasn’t announced any changes to its dividend thus far but William Meadon, manager of the JPMorgan Claverhouse Trust (JCH) thinks a cut is not out of the question.
Commodities have also suffered as resource-hungry China went into lockdown earlier in the year. But as the Asian powerhouse has re-opened its economy and deployed emergency stimulus measures, the asset class has shown signs of recovery, especially iron ore.
The managers of the BlackRock Energy & Resources Income Trust (BERI), Thomas Holl and Mark Hume, favour mining companies for income for a number of reasons. Cheaper oil means energy prices are lower for mining companies, plus a slump in some currencies, such as the Brazilian real, means that labour costs are cheaper – and what they produce is more competitive in global markets.
According to Morningstar Direct data, the trust’s biggest holding is diversified miner BHP (BHP), and it also holds Rio Tinto (RIO). BHP yields just under 5%, while Rio has a dividend yield of 6.7%, and the mining sector has been known for its generous payouts in recent year. Rio did cut its dividend in February but BHP has held firm despite the flurry of cuts across the board. “We’re pretty comfortable with the dividend outlook at the larger end of the mining sector,” says Holl.
Consider Alternatives
Bruce Stout, manager of the Silver-Rated Murray International Trust (MYI), holds a number of airports in the portfolio. Coronavirus has taken its toll on the airline industry, with millions of flights grounded this year and some companies seeking state aid to survive – Germany, for example, has injected cash into national carrier Lufthansa.
So the sector seems an unlikely hunting ground for income fund managers, but could be seen as a recovery play on a return to normality at some point this year, says Stout. He's not alone in this conviction; a number of infrastructure funds are backing airports for their reliable income – although international hubs are expected to be more resilient than regional airports when travel starts to pick up again.
Stout points to New Zeland's Auckland International Airport (AIA) as one example. It has has seen a big jump in flights in recent weeks, from just 500 a day at the height of the pandemic to around 2,000. The trust has a stake in Auckland airport as well as Mexico’s main airport operator, Grupo Aeroportuario de la Ciudad de México, which is the fifth largest holding in the trust. Stout expects leisure travel to bounce back relatively quickly this year, although the outlook for business travel is less certain.
He is also increasingly looking to Asia for income because in general countries in the region are much less heavily indebted than their western counterparts; and emerging market economies in general, with higher interest rates than the developed world, are more likely to respond to monetary stimulus.
Look Closer to Home
UK income investors have had a rough year so far. But, JPMorgan Claverhouse’s Meadon says that historically, the UK has been a good place for dividends, pointing out that over the long term, British businesses have paid out 65% of profits to shareholders, which is higher than the 43% payout ratio in the rest of the world. The FTSE’s yield, which is currently 6-7%, is also at a record premium to 10-year gilt yields, which are currently around 0.20%. After the dividend cuts have been priced in, the FTSE’s yield will drop to around 5%, but this is still much more than bonds and cash are paying.
But where to find reliable dividend payers? Meadon likes life assurance companies such as Legal & General (LGEN) and Prudential (PRU), which we have recently written about in terms of dividends and the coronavirus. “Legal & General has just paid a very substantial dividend, and this at a time when banks aren’t paying any dividends at all,” he says. He is also keen on housebuilders, many of which suspended payouts this year but restarted operations in April and May while many other sectors remained shuttered. Retailer Next (NXT) is also a holding of the trust, and even while shops remain shut, Meadon still expects the company to generate significant cashflow even in a downturn.
Wait and See Approach
These fund managers are under no illusions about how difficult 2020 will be for income seekers. Murray International’s Stout says earnings and cash flow forecasts are impossible to make with no visibility on the recovery, while William Meadon thinks investors will get a much clearer picture on the shape of the recovery by the autumn. Whatever happens, investors in these trusts are still getting a decent yield in a difficult year for dividends: the BlackRock trust is yielding 7%, JPMorgan Claverhouse is paying nearly 5%, and Murray International is paying over 5%.
