Income lessons from a year of turmoil

Investment trusts have cushioned their investors from the worst of the falls in dividends in 2020. However, investors should still take action to ensure their income portfolio is resilient in future.

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.

Investment trusts showed their mettle on income in 2020. Thanks to their reserves, many were able to shore up their payouts to investors, unlike open-ended funds, where investors took the full force of dividend cuts. However, 2020 highlighted a few important elements for dividend seekers in the longer term.

The pandemic has been a once-in-a-generation crisis. As such, it is tempting to think that once it is over, we can simply carry on as before. However, to our mind, it has amplified some investment good practice that investors would do well to heed, crisis or no crisis.

Income diversification

Perhaps the most important lesson of the past year has been one on the importance of diversification. The UK market was tough: the second quarter of 2020 saw 176 companies cancel payouts and 30 implement cuts, together representing three-quarters of all dividend-paying companies1. Certainly, the circumstances were unique – a combination of Brexit, the make-up of the UK market and the pandemic – but it showed the problems of relying on a single market for income.

Those investors that diversified their income across different global regions saw far greater resilience. In the same period, global dividends only dropped by around 20%2, with Asia-Pacific, Japan, the US and emerging markets seeing only small falls in payouts.UK dividends have since started to recover, but investors should recognise that balance is important and confining an income portfolio to the UK – or any other market – could leave them vulnerable.

“…the most important lesson of the past year has been one on the importance of diversification”

Active investment

The pandemic should also demonstrate the importance of active investment. Certain sectors have been hit very badly. Often, these were sectors that, until that point, had been motoring along nicely: at the start of the year, for example, travel and leisure appeared to be poised to benefit from a strong year of economic activity. Today, some sectors, such as the airline industry, look as if they may take many years to recover to their former level of activity.

We take a conviction-led, active approach across the BlackRock investment trust range and as such, we are generally in a good position to navigate this shifting environment. Our managers reassessed their portfolios for a changed world and made the appropriate adjustments. As we see it, investment trust managers have a particular advantage in this type of environment because they are not constrained by the need to manage inflows and outflows.

In this context, elements such as the strength of a company’s balance sheet become particularly important. Companies with strong balance sheets had the resilience to survive periods of lower revenues as businesses shut down in response to the pandemic. They could also invest strategically in their offering and products and keep evolving their business model where necessary to compete more effectively. Our managers can call on BlackRock’s significant analytical resources to make these judgements.

Active managers are also in a good position to assess whether a company is over-distributing on dividends. This was a problem for many companies going into the crisis, particularly in the UK. Companies were hostage to dividend payments they could ill-afford and many were sacrificing the long-term growth potential of their business. The crisis exposed the frailties of weak business models that have underinvested with unsustainable levels of debt.

Looking to recovery

We believe this bifurcation among companies may become more pronounced as we emerge from the pandemic. Our active managers can adapt their portfolios for tomorrow’s world. The pandemic, when it is finally over, will have reshaped our collective psyche in many ways. Will we return to the office, for example? To crowded cinemas? To commuter trains or shops? Technology has become more important in our lives. A renewed focus on environmental, social and governance factors when investing also appears set to stay. At BlackRock, we are always exploring these themes and looking at how they might affect investment markets.

Long-term dividend growth is every bit as important as a high absolute dividend. Growing payouts are the natural result of a company that is growing its earnings and cash flow and operating in a sustainable way. Being able to invest with an eye to the future is vitally important to capture this rising income stream.

ISAs are a tax-efficient way to manage an income portfolio. With all income received from an ISA paid tax-free, it can be an invaluable tool to build up a long-term income stream, but it is important to learn the lessons from a tumultuous year for income investors.

Unless otherwise stated all data is sourced from BlackRock as at February 2021.

1Link Group, July 2020
2Citywire, November 2020