Funds and trusts that have held up best in the dividend drought

Amid a challenging dividend backdrop, these income funds and trusts have best protected capital.

It has been a turbulent time for dividends as companies slam the brakes on payouts in response to Covid-19 turmoil. The UK was the worst-hit region by far for dividend cuts in the second quarter of the year, with payouts falling 54.2%, according to Janus Henderson’s Global Dividend Index. 

This has fed through to income-focused funds and investment trusts, with every single fund in both the Association of Investment Companies (AIC) and Investment Association (IA) UK Equity Income sectors posting a negative return year-to-date (to 18 August).

Dividends paid out by companies are a key part of funds’ revenue streams which enables them to pay income to their end investors. Investment trusts are able to use their capital reserves to maintain their payouts even when dividends in the marketplace are squeezed, but this option is not available to open-ended funds.

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How have funds performed?

The average fund in the AIC sector has fallen 23.4%, with the worst performer, the British & American (LSE:BAF), down 52.8%. Among open-ended funds, the average return from the IA peer group is -19.3%, with UBS UK Equity Income the worst hit, down 32%.

The best performer in the AIC UK Equity Income sector over the period is Finsbury Growth & Income (LSE:FGT), down 6%. The second-best is Premier Miton's Diverse Income Trust (LSE:DIVI), down 7%. It managed to keep a lid on year-to-date losses by using a form of portfolio insurance. Investment trust analyst Numis said the trust had gained a significant performance boost from using “a long-held FTSE 100 put option during the market downturn in March”. This option insulated the portfolio against the market sell-off.

The best performer in the IA UK Equity Income sector is LF Miton UK Multi Cap Income, down 2.4%.

Top five performing UK equity income funds in dividend drought 

Source: FE Analytics. Figures from 1 January 2020 to 18 August 2020. 

Top five performing UK equity income trusts in dividend drought 

Source: FE Analytics. Figures from 1 January 2020 to 18 August 2020. 

‘Unprecedented outside wartime’

Paul Angell, investment research analyst at Square Mile, suggested most investors would bite your hand off for a -2% return given the wider context for funds. “We’ve had one of the most violent market drawdowns driven by the most dramatic event that has happened in generations,” he says. The knock-on impact on companies is that they can no longer pay dividends while they are struggling to stay profitable, or are feeling political pressure to suspend payouts. What we are seeing right now in terms of business disruption is “unprecedented outside of wartime”, says Angell.

Those funds posting 30% falls are likely to be the ones holding financial stocks and oil and gas, which have been especially hard hit by economic disruption and a plunging oil price. “Of course, investors should be disappointed with 30% drawdowns over the year, but actually some of those single-figure drawdowns look pretty respectable given the amount of disruption in markets,” Angell adds.

The difference between those funds that hold up well and those that struggle will be how much exposure to the UK and cyclical sectors they have, agrees Richard Cole, fund manager at Future Money. He points to BlackRock UK Income (-11.7% year-to-date), which has proved fairly defensive because of its underweight to the UK and higher US exposure, which pre-dated the current crisis. It has also been underweight financials and energy, which have been responsible for the lion’s share of dividend cuts. 

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Special dividends ahead?

Looking forward, Angell says that some of the fund managers he has spoken to expect companies to pay special dividends later in the year to make up for missed payments. He says managers anticipate 20%-50% dividend cuts on the FTSE All-Share this year, while expecting dividends to return to 90% of normal levels by 2022, and completely back to normal by 2024.

Cole says fund managers have told him that they are pleased companies are being prudent with cash, cutting dividends in order to get through the crisis.

“The managers we’ve been speaking to have generally been quite welcoming of the cuts because they can see that they are needed for the long-term health of the company. They have been largely willing to accept this and are putting out the message that, yes, it will be a bad year for income but it will recover. I haven’t seen evidence of many managers changing the way they do things to prop up the dividend over the next 12 months.”

A reset for more sustainable yields

In fact, the present challenge could even be good for the equity income space because it will make yields more sustainable in the long run, Cole suggests. “This kind of reset is going to mean dividend growth can come year in, year out, but from a more sustainable level. So, it is easy to see doom and gloom and, for investors that do need that cash, this year is going to be difficult, but for the longer-term health of the market I think this could actually be a fairly good thing.”

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.