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The challenge for income investors in a COVID-19 world.

By John Stopford, Co-Portfolio Manager of the VitalityInvest Ninety One Multi-Asset Income Fund

Published: 7th May 2020
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COVID-19 has put increased pressure on income-seeking investors as the ability of companies to pay out planned or expected dividends is understandably being questioned. Furthermore, some governments have applied indirect or direct pressure to certain industries to reconsider their dividend payouts on the basis that, in their view, in this time of financial difficulty for many people, shareholders should not be rewarded. As a result, across the market, we have seen a number of companies cut, cancel or suspend dividends.
This presents a conundrum for income investors, with the reduction of these payouts forcing them to reconsider how they look for attractive, sustainable sources of yield. We believe the winners and losers will be separated by factors of sustainability of income, which relies on the fundamental quality of the companies in a portfolio.

Our approach to dividends

In an economic crisis of this size, liquidity is key, with companies desperate to preserve cash as a balance sheet buffer. Companies often respond to the need to hoard cash by cutting dividends, and while this is understandable, it doesn’t bode well for income investors reliant on these payments. 

But we think there’s a fundamental problem with dividend-hunting, which may have left investors unnecessarily exposed to dividend risk. Many companies will often take on additional leverage just to maintain those dividends, rather than these distributions being based on ‘natural profitability’ generated by robust business models. This means that chasing stocks with the highest dividends may result in investors holding highly leveraged companies. Unfortunately, this spike in dividend risk facing income investors will continue for many months as companies adapt to the new world with less liquidity. 

Going forward, avoiding over-leveraged companies and any signs of creative accounting will be crucial to finding sustainable dividends. The key focus for investors should be on a deep focus on a company’s profitability and capital allocation decisions across their supply chains. At Ninety One, we want to have full understanding of what’s in our portfolios at any given time. The result is a highly differentiated portfolio of stocks – one that we believe can continue to provide the risk-adjusted returns we’re seeking. 

Opportunities

Valuations were transformed after the COVID-19 crash. But, with the unprecedented response from governments and central banks, the amount of liquidity which flushed the market resulted in rapid stabilisation. Now, the yield on our investible universe is the highest we’ve seen in several years. 

In the immediate aftermath of the crisis, corporate bonds presented the most attractive opportunity, as the forced liquidation by many investors during the sell-off led to underperformance. This led to yields increasing significantly, prompting a rally as markets stabilised. In particular, we believe many high-quality investment grade companies are creating very attractive risk-reward opportunities. We also see selective opportunities in high yield debt, listed infrastructure and across equities.

COVID-19 has been sudden, however, for the patient investor this has generated new opportunities, with headline yields looking attractive at current valuations. At Ninety One, we’re always researching new investment opportunities, seeking to uncover those resilient businesses that can offer sustainable incomes, and thereby helping investors meet their long-term investment goals. 


Important information
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.

VitalityInvest is a trading name of Vitality Corporate Services Limited. Vitality Corporate Services Limited is authorised and regulated by the Financial Conduct Authority. 07/05/2020 | This article’s view is based on the law, practices and conditions as at the day of publication. While we have made every effort to ensure they are accurate, we accept no responsibility for our interpretation or any future changes. | VI O 0090

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