Is the dividend drought over?

After a torrid year for those in UK equity income funds, investors will be buoyed by the news that in the first quarter of this year UK dividends fell at their slowest rate since the pandemic began.

According to the latest UK Dividend Monitor from Link Group, compared with the 48.2% collapse in underlying dividends in the second quarter of 2020, payments in Q1 2021 fell by 26.7% to £12.7bn which is the slowest rate of decline in the last 12 months.

To put this into context, according to Link Group over the last 12 months the pandemic has caused a 41.6% fall in dividends, with cuts totalling £44.8bn as some two-thirds of companies were forced to made reductions.

However in a sign that a recovery may on way, half of UK companies either increased, restarted or held dividends steady in Q1, compared with just one third in the fourth quarter of last year. Additionally of the £5.8bn of dividend cuts that were made in the first quarter, about half came from just one sector, oil.

“After the year-long pandemic winter for dividends, the buds of spring are about to burst into bloom,” said Ian Stokes, managing director of Corporate Markets Emea, part of the Link Group. “It’s hard to characterise the big drop in the first quarter as anything but bad news, but look closer and the green shoots are already sprouting.”

Unsustainable levels

A look at fund flows in the IA UK Equity Income sector shows what a tough year it has been, with investors pulling out a net £3.3bn over 12 months to February. In February this year, the IA revealed that some £660m was redeemed from the sector.

Adrian Lowcock (pictured), head of personal investing at Willis Owen, said that it is important that income seekers and investors look through the drop in dividends in Q1 as the comparison to 12 months ago reflects a largely pre-pandemic world.

“Most of the drop in dividends this quarter has been linked to announcements previously made and therefore fully expected,” he said. “Investors should instead turn their attention to how income is recovering and most importantly the quality of that income.”

See also: Which UK equity income funds saw yields shrivel during the coronavirus pandemic?

For Lowcock 2020 was an “eye opener” for investors and highlighted the fact that many companies’ yields were unsustainable.

“From here the quality in equity income in the UK is much improved, some companies have reset their dividends to manageable levels, whilst other sectors should return now the political and economic pressure is easing,” he said. “Dividends from financials, in particular banks, should help drive growth whilst the commodity cycle is providing some good news for miners.”

He added: “Whilst it may take a few years for yields to get back to 2019 levels, investors should be able to recover more quickly by focusing on the quality.”

Banks and miners will be the dividend trail blazers in Q2 and beyond

Looking ahead, Stokes noted that Link expects banking and mining stocks to continue to improve their dividend payments in the second quarter and beyond.

“Investec blazed the trail in Q1, but Q2 will see all banks start paying again,” he said. “The commodity boom is leading to a surge in mining dividends too, but we expect growth to get stronger and broader over the next six months.

“Crucially we increasingly see limits to the downside this year, though we caution that 2025 still looks like the most realistic moment for dividends to match their 2019 high point.”

Ryan Hughes, head of active portfolios at AJ Bell Investments, said signs dividends are recovering should give investors confidence that companies have come through the worst of the pandemic and have the confidence to start distributing profits again.

“As the vaccine roll out continues at a pace and the economy begins to open up, positive signs of a divided recovery are emerging which could certainly make equity income strategies more appealing, not least given the close correlation with the value style of investing that has performed so strongly in recent months,” Hughes said.

Investment trusts shine amid aggressive dividend cuts

However, Hughes added the depths of the scarring are clear with it taking a number of years before the aggregate amount of dividends returns to pre-Covid levels.

“The dividend issue also put investment trusts back in the spotlight as a way of investors mitigating the volatility around income given their ability to smooth payments and use reserves,” he said.

“Therefore as investors potentially re-focus on income generating equities, the importance of choosing the right structure to do this should be a key learning point of the last 18 months.”

See also: DFMs tap investment trusts for income and alternatives during pandemic