Still searching for income

While the death of dividends has been greatly exaggerated, the Covid-19 pandemic has put them on life-support. Can credit step up to provide the income investors need?

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Dividends have been a steady source of income for investors, with the FTSE 100 alone paying out £89 billion to shareholders in 2018. However, fears of a global slowdown, along with fewer companies going public, have reduced shareholder’s take to £73 billion in 2019. Covid-19 pandemic is likely to cut that to as little as £50 billion in 2020.1

As the income from dividends dries up, investors will look for opportunity in new markets. Credit is an attractive alternative, but investors must be aware of how events have changed the market. The pandemic’s uneven impact, and the variance in government response mean there will be a significant dispersion in credit performance. Meanwhile, low or even zero interest rates have made it harder to find yield in liquid credit investments.

In this environment, private credit instruments may provide the best opportunities. But to take advantage, investors must first understand the current financial and economic context, the factors driving performance and the types of investments available.

Stock Symptoms

Dividend growth was slowing even before the pandemic. In 2019, global dividends grew just 3.5%, compared to growth of 10% and 8% in 2018 and 2017, respectively.2 However, the pandemic has had a clear impact on dividends globally, and it is expected to do so for some time. Global dividend pay-outs from large corporations fell 22% to USD 382.2 billion in the second quarter of 2020 - the worst quarterly drop in eight years – with more than half of companies expected to pay a dividend cancelling and another quarter reducing their dividends. Predictions for the year range from a drop of 19%, to USD 1.18 trillion in dividends globally, to a fall of 25% (USD 1.1 trillion).3 With the road to economic recovery uncertain, future prospects for dividends also are unclear. 

To your credit

In contrast, credit markets – both public and private - are growing. Public debt includes investment grade and high yield bonds and traded bank loans, while private debt covers direct lending to mostly middle market companies and distressed debt/special situations.

Typically, falling Gross Domestic Product leads to a decline in public bond issuance but that has not been the case this time. In response to the initial shock of the pandemic, there was a broad and deep credit sell-off and issuance ground to a halt (as did most financial markets). But there has been a dramatic retracement since, as companies quickly saw that they must shore up their capital reserves in the face of economic uncertainty. Year to date, over USD 2.1 trillion of new corporate debt has been issued globally across investment grade and non-investment grade credit markets - 60% more than in the same period last year4.

In considering the impact of the pandemic on public credit investments, there are clear sectoral differences, with some industries like travel and hospitality severely challenged, while others like technology, consumer staples, homebuilders and retail essentials have benefitted. This greater dispersion – and spread volatility - across sectors leads to greater investment opportunities across the market.

Similarly, there has been of divergence of the impact on investment versus non-investment grade debt. Investment-grade companies have issued the most since the pandemic struck, as they find it easiest to tap the market and they have been the main beneficiaries of the unprecedented fiscal and monetary support from governments7. In contrast, in the non-investment-grade space, credit ratings agencies moved quickly to downgrade many companies and markets reacted - high-yield markets priced in over 50% of companies defaulting. That has reduced to approximately 30% today but spreads remain near the 80th percentile over the last decade, potentially a good point to invest.7

Private debt instruments tend to be better protected from broad credit-market movements, and provide better opportunities for returns and diversification. Now is the time to consider more specialist areas like distressed debt or special situations, which are growing due to the pandemic. Many issuers entered the crisis with elevated leverage ratios, and the crisis has put pressure on a wider range of companies, so available demand for capital is likely to outstrip supply - creating opportunities to provide unique financing solutions.

Pockets of value can be found amidst the debris. Higher credit dispersion and spread volatility, elevated risk premiums, and tighter covenants for lending in both public and private markets are fuelling growth. A simultaneous growth in the demand for capital solutions that cannot be financed in traditional public markets, means there is even greater opportunity for income. How investors will take advantage, remains to be seen.

Risk: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy

1 Spear’s, Cover Story: Is this the death of dividends?, June 2020

2 Barron’s, Global Dividends Hit a Record $1.4 Trillion in 2019. Their Growth Rate Slowed, However., February 2020

3 Funds Europe, Global dividends plunged a fifth in Q2, August 2020.

4 BlackRock, A credit cycle like no other, As of June 30, 2020

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