Global investors have had a harrowing time in recent years with the pandemic, which has created a perfect storm for income investors who have endured a dividend landscape decimated by widespread deferrals, reductions, suspensions and cancellations of payments. In the UK, almost half of the FTSE 100 companies have announced measures to deal with the pandemic in 2020, with many facing increasing regulatory and political pressure to withdraw payments during the crisis. The watershed moment was the decision by Shell, the largest dividend payer in the UK, to cut its dividend for the first time since WW2. Dividends remain the main driver of total return and more so if they are re-invested. Although there is the prospect of a change in monetary policy and the potential rise in global interest rates from an ultra-low base, investors are faced with low returns on cash deposits and diminishing yields from fixed interest instruments.
Responsible Yield: changing landscape
The landscape is set to change in marked manner in 2021, in which dividends hit an all-time high for Q3 with £404bn paid out. The forecast of $1.5 trillion for the year is set to surpass the pre-pandemic pay out in the 12 months to March 2020. The strength of the bounce back is best evidenced by the fact that 90% of companies globally have either raised or held their dividends, supported by surging profits and robust balance sheets. However, the rise in dividends has been led by mining companies, which are not investible for ESG investors in the main. The mining sector is set to deliver more in dividends in the third quarter of this year than for the whole of 2019, which was the record year for the sector. The largest dividend payer globally in 2021 will BHP Group, with Rio Tinto, Vale and Fortesque Metals Group in the top five payers.
In addition, the strong rise in the oil price augurs well for the global oil majors who are now yielding well over 4% on average. The challenge for responsible investors is to deliver on their yield needs despite the marked changes in the dividend landscape. In the UK, the concentration risk in the UK will increase with fossil fuel companies leading on both growth and yield in 2022. Over 60% of the dividends paid out in the UK comes from 15 companies, most of which are not investible (Tobacco, Alcohol, Defence and Fossil Fuels) for ESG investors. So where can ESG investors find rich pockets of not only yield, but also growing and secure dividends?
Healthcare: quality and sustainable Income
There are still pockets of the market, which are offering stable and often growing income for ESG investors, allowing them to deliver on their financial commitments whilst maintaining their principles. One such pocket is the Healthcare industry, which is naturally aligned to the values of many ESG investors, playing a vital role in expanding access to medicine and delivering affordable healthcare. The vital role played by the sector during the pandemic has been very evident.
The Healthcare industry is often viewed as homogenous by many investors, but the breadth and depth offered at a sector level is second to none. The diverse Healthcare industry includes well-established global companies operating in the research and development (R&D) of drugs, biotechnology, diagnostics, drug distribution, medical technology and animal health, all of which provide rich opportunities for income investors. Whilst the large cap R&D pharmaceutical giants (GlaxoSmithKline, Roche, Novartis, Pfizer, Abbvie, Merck, Takeda and Bristol Myers-Squibb) are widely held in income portfolios, there are many candidates in the other sectors offering income investors both yield and growth. Examples include Medtronic, Bioventix, Smith & Nephew, Gilead and Amgen.
Income investors, when constructing their portfolios, often define their universe as three distinct buckets – defensive, quality and growth. Healthcare is uniquely positioned to deliver on all three with large cap pharma’s defensive business model delivering income well in excess of 4%. There has not been a dividend cut in this part of the market for well over twenty years, excluding M&A. All three buckets are well represented at a sector and geographical level, allowing access for investors across the global healthcare landscape.
Financials: growing yield
The banking sector has returned fully to the dividend list post a regulatory moratorium during the pandemic and is well set for a strong 2022, when interest rates are forecast to rise. Whilst some banking business models can be challenging for ESG investors, domestic focused banks focused on mortgage books like Lloyds are strong candidates for inclusion in a dividend portfolio. However, the quality part of financials is the insurance sector, which offers high and growing yields. Examples here include Legal & General, Aviva, Admiral, Sabre, Direct Line and Phoenix Group in the US and further afield, Swiss RE, Allianz and a.s.r Nederland, all of which are yielding 5-7%.
The FAANGs (Facebook, Apple, Amazon, Netflix and Google) have driven US indices to record highs, but for the most part would not be suitable ESG investors who are income led, as most of these names pay little or no dividends. However, the broader mature technology names remain well placed on both the ESG and income front. Examples include Cisco Systems, Microsoft, Intel, ADP, Paychex and TSMC.
Diversification: Telecoms, REITs, Infrastructure Funds and Housebuilders
There is a wide range of sectors that can help achieve diversification for ESG investors. Telecom businesses are facing the challenge of financing 5G infrastructure, but still remain solid income plays and examples include Vodafone, Orange, KPN, Telenor, Swisscom and Deutsche Telekom. In the UK, the housebuilding sector is awash with cash and strong balance, the exact opposite how it was in 2008. Income plays include Taylor Wimpey, Bellway, Berkeley and Vistry.
REITs (Real Estate Investment Trusts) have had a very turbulent time during the pandemic, with the added pressure of online disruption and many funds were closed leaving investors with no access to their investments. However, specialist REITs which focus on warehouses and logistics have done very well during the pandemic and now trade at a significant premium to NAV. However, there are some segments that offer yields of over 6% such as Civitas, which focuses on social housing and PRS REIT, which offers access to the private rental market. The slew of infrastructure funds launched recently provides ESG investors a great opportunity to add both yield and diversification.
Global Dividends: Responsible & Sustainable
The challenging landscape for income investors can be navigated by adopting a wider net to ensure a more diversified income stream. The length and impact of the pandemic will be difficult to predict, but those investors who are willing to search out companies operating in strong end markets with high barriers to entry, conservative balance sheets, strong cash flow generation, high recurring revenues and long tenured and aligned management will be rewarded in the long-tem. Although there is much to be concerned about on the economic and political front, there are large sections of the market like Healthcare, Technology and Financials that offer quality and sustainable income for those ESG investors who can adopt a global lens when constructing their portfolios.
The views contained herein are not to be taken as advice or recommendation to buy or sell any investment or interest. The value of an investment and the income from it can fall as well as rise, you may not get back the amount originally invested. Past performance should not be seen as a guide to future performance. EdenTree is authorised and regulated by the Financial Conduct Authority and is a member of the Investment Association. Firm Reference Number 527473.