10 dividend shares to protect your portfolio from the weak pound

With UK dividend investors about to get a multi-billion-pound boost, stock screen expert Ben Hobson discovers the high-yielding shares every income hunter should know about.

Recent volatility between the British pound and US dollar is a reminder that foreign exchange rates can impact on investment returns. But while short-term movements grab headlines, it is the longer-term trends that can be much more important - especially for dividend investors.

When it comes to economic fireworks, the recent mini-budget from Kwasi Kwarteng and Liz Truss was undeniably dramatic. Whatever the pros and cons of their approach, one outcome that really captured attention was how it caused the value of the pound to slip to near parity with the US dollar.

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Exchange rate movements can have an instant impact on some firms. Yet short-term changes are so unpredictable that regular equity investors are often best ignoring them. You only need to look at how quickly the pound recovered against the dollar this week to see how easy it is to be caught out.

Despite the erratic nature of short-term rates, sudden moves tend to trigger scary headlines. Over the course of a few days, financial news went from agonising about the ‘slump’ in the pound, to hailing its subsequent ‘surge’.

What all this ignores is that the US dollar has been strengthening against the pound for many months. Even before the recent volatility, the pound was trading close to a five-year low against the dollar. For investors, that is a much more important trend to be aware of.

Source: Bank of England

Making sense of currencies and exchange rates

Exchange rates are a factor for any company that buys or sells abroad. Larger firms often hedge their exposure, so these changes don’t interfere too much with their financial results.

From a UK investor’s perspective, the currency of a company’s earnings and dividend distributions can be important, especially when there is an entrenched trend in exchange rates like we’re seeing now.

For example, some UK-quoted companies that operate abroad report their results in US dollars and pay dividends in dollars, too. You literally get more bang for your buck when those dollars are exchanged into pounds. Likewise, some firms report in US dollars but pay dividends in British pounds - and again, the investor gets the benefit of dollars being exchanged for pounds.

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According to Link Asset Services, which tracks UK dividends, two-fifths of dividends paid in the second quarter of this year were in US dollars. That equated to an enormous exchange rate boost of £1.4 billion. Full-year estimates - which were made before further weakness in the pound - suggest that the exchange rate will add between £3.5 billion and £4.5 billion to the 2022 total.

Unsurprisingly, when you look at companies across the UK market that report their results in US dollars, a significant number are in basic materials and energy industries. That is because commodities like oil, gas and metals are priced in dollars.

Companies in those sectors have seen their share prices trend higher this year because energy and some mining commodities have done very well. For investors, an extra kicker is that those profits buy more pounds, which is a big benefit for dividends.

But it’s not just those industries that income hunters should watch for. This screening approach looks for the highest forecast yields on offer from companies in the UK that report their results in US dollars. It also shows whether the dividends are paid in dollars or pounds and how well covered by annual earnings those dividends are (as shown by the dividend cover).

This selection of companies from the results shows that you do come across other firms in a variety of sectors that are either US based or choose to report in dollars. Somero Enterprises (LSE:SOM), the American concrete screeding specialist, is one example that many individual investors will know well - which is currently on a forecast yield of 9.6%.

Spectra Systems (LSE:SPSYis another US small-cap stock quoted in the UK. It specialises in secure transactions and its shares have held up better than many others on the AIM market this year. It has a forecast yield of 6.4%.

Shares in financial industries are also commonly seen reporting in dollars. Hedge fund giant Man Group (LSE:EMG) and trading technology company Plus500 Ltd (LSE:PLUS) have forecast yields of 5.6% and 4.9% respectively. They also have some of the highest dividend cover on their payouts in this list.

Diversifying your dividends

Portfolio management textbooks tend to suggest ignoring short-term movements in exchange rates. But there is a strong case for thinking about the impact that different currencies might have on your returns - especially when it comes to dividends.

Recent evidence shows that the medium-term exchange rate trend between GBP and USD has created a dollar premium in the payouts being made by British companies this year.

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In more normal times, investors are generally urged to diversify their market exposure by either investing in foreign shares or British-based shares that have big international revenues. This has the benefit of not leaving you reliant on your home market economy should it hit trouble. But exchange rates are clearly an important factor too. In a year when returns have been under severe pressure, dividends, especially those that were earned in US dollars, have been a welcome boost.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.