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The Great Dividend Crisis

The value of your investment and any income from it is not guaranteed and may go down as well as up and as a result your capital may be at risk.

Unprecedented. That is the only word to describe the collapse of corporate dividends as a result of the Covid-19 pandemic. The scale of the setback has exceeded even that from the Great Financial Crisis just over a decade ago, particularly in the UK. Whole sectors such as banks and oil companies have had to cut their dividends, and many others in sectors such as property and retail have been severely affected by the lockdown and the associated economic slowdown. For those relying on income from equities, it is hard to know what to do or where to turn, particularly as ‘cutting losses’ and buying other seemingly high-yielding companies has often led to serial disappointment as they too have run into trouble.

Happily, despite the turmoil in markets and the considerable ongoing economic uncertainty, there is also a huge opportunity. Because the beauty of equity markets is that, as an active investor, you can avoid the companies and business models of yesterday and invest instead in the shares of the future. That may limit your dividend income in 2020, as these companies have a lower yield than others which are ex-growth. But in the long-term, if you find these sustainable companies, it is likely to pay off in far higher levels of income, together with strong capital appreciation.

For every company facing a prolonged period of troubled times, there is another for which Covid-19 will ultimately prove transitory. Great companies with relevant business models will undoubtedly see earnings and dividends bounce back. Well-run insurance companies, for instance, will continue to play a vital role in protecting policyholders against disasters – and the value of that insurance may well be higher in a post-pandemic world. Innovative manufacturing companies, with products that genuinely enhance the efficiency of their customers, will see their earnings bounce back too, and delivery companies will find their services in ever-greater demand. The question for dividend investors to ask therefore is not: What companies can I buy to plug this year’s income gap? It is rather: What companies do I believe have a strong future once this crisis has passed?

Our mantra as income managers is ‘long-term income, not short-term yield’.

Importantly though, we also believe that you should be demanding of the businesses you invest in. If you’re investing for long-term income and seeking to deliver an income stream which outpaces inflation, set a high bar that only accepts genuine growth businesses. In our experience, companies that can grow their earnings to support higher dividends in five- or ten-years’ time are far more rewarding investments than short-term ‘yield plays’. That is why we largely avoid the mature, ex-growth companies that have propped up the market’s yield. In the long term, dependable income requires sustained earnings growth.

However, businesses which are both dependable and have good growth prospects are in short supply, so part of the solution is to scour the whole world for the dividend-paying companies with the best prospects: go global. This will assist the escape from the risks of the UK oil companies, the banks, the high street retailers, and the other troubled companies that make up so much of the UK dividend sector. Our own experience has been that going global is incredibly liberating and rewarding.

Dividend investors can survive this unprecedented setback. They can do so by exercising the discipline of a long-term approach and actively picking the winning cash-generating companies of the future. Owning a global portfolio of such businesses, we believe, offers a terrific opportunity for future growth in income and capital.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Baillie Gifford & Co and Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investments trusts managed by Baillie Gifford & Co Limited are listed UK companies and are not authorised and regulated by the Financial Conduct Authority.

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About the author

James Dow, Co-head of Global Income Growth, Baillie Gifford & Co.

James was appointed Co-Head of the Global Income Growth Team and Co-Manager of The Scottish American Investment Company PLC (SAINTS) in 2017. He joined Baillie Gifford in 2004 on the Graduate Scheme and became an Investment Manager in our US Equities Team. Previously, James spent three years working at The Scotsman newspaper, where he was the Economics Editor. He is a CFA Charterholder, graduated MA (Hons) in Economics-Philosophy from the University of St Andrews in 2000 and MSc in Development Studies from the London School of Economics in 2001.

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