25 February, 2021

 

The COVID-19 crisis shocked economies across the globe, and the resulting spirit of corporate prudence and regulatory action has led many firms to reduce or cease paying dividends.1 In a world where interest rates are low and alternative sources of income are limited, the current crisis has potential long-term implications for investors that rely on dividends as a source of income. As a follow-up to our 2019 publication, Dividend Investing — A Global Equity Perspective,2 this article provides some historical context and a comparison to the current crisis. We conclude that forward-looking, actively managed investment approaches should be the preferred option for equity investors seeking to allocate to dividend focused strategies.

Dividends during times of crisis

Although each economic crisis is unique in how it impacts the economy, ceasing or limiting dividends is a common response. From the perspective of a dividend investor, certain sectors tend to weather these crises better than others. While individual companies can be hurt by idiosyncratic risks, economic sensitivity plays a significant role in how profitability varies across sectors. Businesses operating in sectors such as consumer staples and healthcare, whose sales are nondiscretionary and whose profits are thus less volatile, can continue to pay dividends during an economic downturn. In contrast, companies in other, more cyclical areas of the market, such as financials and materials, typically suffer in times of crisis and may be forced to reduce or discontinue cash payments to shareholders.

The variability in dividends across different sectors is illustrated in Figure 1.

Figure 1. Growth in dividends in various MSCI World sectors versus the MSCI World Index (rebased to 100 at 31 January 1995)3

 

Source: Bloomberg.

Figure 2 highlights the maximum peak-to-trough decline in dividends for each of the GICS sectors in the period from January 31, 1995, to December 31, 2020.4

Figure 2. Peak-to-trough fall in dividends5  

 

MSCI Sector

 

Maximum peak-to-trough fall in dividends

Date range for peak to trough fall

Time taken to recover the maximum peak to trough fall in dividends (months)

Energy

-16%

Apr 15 to Dec 16

33

Healthcare

-18%

Aug 99 to Dec 00

26

Utilities

-21%

Apr 11 to Nov 16

81

Consumer Staples

-21%

Mar 08 to Oct 08

31

Industrials

-30%

Jun 08 to May 10

43

MSCI World

-32%

May 08 to May 10

64

Materials

-41%

May 08 to May 10

56

Consumer Discretionary

-43%

Oct 98 to Nov 02

90

Telecom Services

-52%

Nov 96 to Sep 01

101

IT

-64%

May 05 to Nov 05

90

Financials

-64%

Apr 08 to Feb 10

145+

Source: Bloomberg.

Dividends and the last three market crises

During the global financial crisis (GFC), the gross value of dividends distributed by companies in the MSCI World Index fell 32% from its peak in May 2008 and took 64 months to recover to that same level. Within the MSCI World Index, some sources of income were permanently impaired by this crisis, and others proved to be much more resilient, not falling as far and recovering more quickly.

The dot-com bubble crisis hurt a different group of sectors than the GFC, and the fall in dividends was less pronounced. This is likely due to the severity and length of the economic contraction during the GFC and the focus of the dot-com bubble on telecom services and IT stocks — the latter were not significant dividend payers at the time.

The current crisis is very different from the previous two. With much of the global population experiencing some form of lockdown during 2020, transportation came to a grinding halt (a feature not present in other economic crises), and energy prices tumbled. This situation has led to some of the oil majors, such as Royal Dutch Shell,6 cutting dividends for the first time in decades. Structural changes to work and travel patterns resulting from the COVID-19 pandemic have long-term implications for airlines, commercial real estate and a host of other industries. By contrast, the healthcare and consumer staples sectors have been the least affected by COVID-19 as of the current analysis. This is consistent with past market sell-offs.

The table below highlights the maximum peak-to-trough decline in dividend distributions experienced by each of the GICS sectors within the MSCI World Index during the last three crises.7

Figure 3. Peak-to-trough fall in dividends in crises

 

MSCI Sector

 

Peak-to-trough fall in dividends

COVID-19

GFC

Dot.com

Healthcare

-1%

-6%

-18%

Consumer Staples

-2%

-21%

-11%

Utilities

-4%

-11%

-16%

IT

-5%

-9%

-43%

Telecom Services

-5%

-14%

-50%

Energy

-12%

-15%

-11%

MSCI World

-13%

-32%

-12%

Industrials

-18%

-30%

-10%

Financials

-27%

-64%

-5%

Materials

-27%

-41%

-13%

Consumer Discretionary

-35%

-38%

-43%

 Source: Bloomberg. Dividends are in US dollars.

History shows us that some predictable elements are associated with the ability of companies to return capital to shareholders during the most severe equity market sell-offs. However, there are also elements unique to each underlying crisis and certain parts of the market that are more exposed to change. For this reason, we believe a forward-looking investment approach, which can both bias a portfolio toward long-term winners and react to fundamental changes in the market environment, is best-suited to investors who allocate to dividend-oriented strategies. We believe this is of paramount importance during crises where long-term trends can be accelerated (for example, climate transition) and business model viability is tested. Below, we explore the performance of active management in the equity income space during the past two crises, the GFC and COVID-19.8  

How has active management performed in past crises?

We have analyzed the manager-reported performance of active equity income managers in Mercer’s global equity universe9 against the MSCI World High Dividend Yield Index during the GFC and the COVID-19 crisis.10 We have included the MSCI World Index to provide some perspective on how high-yielding companies have performed relative to the broad market in each of these periods.11

Figure 4. Performance of income strategies versus the MSCI World Index during the GFC

Source: MercerInsight®. Figures are in US dollars.12





Figure 5. Performance of income strategies versus the MSCI World Index during the first three quarters of the COVID-19 crisis


 

 Source: MercerInsight®. Figures are in US dollars.13

The charts above indicate that active global equity income strategies have fared positively in navigating the most recent market crises and support our preference for active, fundamental strategies in this space.14

We believe there are several reasons active equity income managers have outperformed the MSCI World High Dividend Yield Index during recent crises. We highlight three of these reasons below:

  1. Active managers are able to form a view of company management’s attitude to capital discipline, weigh up reinvestment opportunities carefully and make informed decisions about whether management teams are committed to paying dividends to shareholders.

  2. Active managers can not only focus on income but also assess the sustainability of future income growth.

  3. Active managers are able to actively manage risk depending on the market environment, balance the trade-off between conviction and diversification, and mitigate the negative impacts of a crisis when some industries are more vulnerable to dividend cuts.

Conclusion

For many investors, reliance on income from dividends has increased with low (and, in some cases, negative) interest rates. The COVID-19 crisis has now hit dividends as a source of investment income, with the MSCI World Index experiencing a 13% decline in dividends during 2020. However, an examination of historic data suggests that investors in active equity income strategies have generally fared positively. 

In our view, the positive performance of active management in the equity income space is attributable to the forward-looking aspect of most active strategies and their ability to react to a changing market environment. It underscores the importance of not making investment decisions based on headline yield and naive quantitative inputs. Instead, we believe qualitative aspects of a dividend-oriented investment approach should be emphasized, including the clarity of the investment philosophy, robustness of the process, quality of the investment team and approach to risk management. We believe active, forward-looking strategies sufficiently diversified by sector and geography and focusing on sustainability of dividends through a cycle are more likely to succeed, both during and after a crisis.


Authors

Duggie Hawkins
Duggie Hawkins
Asset Class Specialist | Equity Boutique
Paulleeta Haggith
Paulleeta Haggith
Asset Class Specialist | Equity Boutique

[1] For example, UK banks agreed to suspend dividends until at least the end of 2020, and the Federal Reserve has placed a cap on dividend payments for US banks with assets over $100 billion. Ackerman A. “Fed Caps Big Banks’ Dividends, Halts Share Buybacks in Fourth Quarter,” The Wall Street Journal, September 30, 2020, available at https://www.wsj.com/articles/fed-caps-big-banks-dividends-halts-share-buybacks-in-fourth-quarter-11601497050.

[2] Mercer. Dividend Investing — A Global Equity Perspective, 2019, available at https://www.mercer.com/content/dam/mercer/attachments/private/nurture-cycle/gl-2019-wealth-dividend-investing-a-global-equity-perspective-mercer.pdf.

[3] The dividend metric used in the chart is defined as gross trailing-12-month “ex” dividends, including special cash dividends. It is calculated by summing all constituents’ dividends per share multiplied by shares in the index, divided by the index divisor. Dividends are in US dollars.

[4] See footnote 3 for details on dividend definition and calculation. Dividends are in US dollars.

[5] Please note that the data are inclusive of special dividends, which can have a material impact on the drawdown data. For example, the maximum drawdown in the IT sector occurred as a result of a large special dividend paid by Microsoft in November 2004.

[6] Hurst L. “Royal Dutch Shell Cuts Dividend for First Time Since World War Two,” Bloomberg, April 29, 2020, available at https://www.bloomberg.com/news/articles/2020-04-30/shell-cuts-dividend-as-pandemic-hammers-energy-prices-demand.

[7] The maximum drawdown is defined as the peak-to-trough decline in dividend payments for each sector. Periods used for each crisis are as follows: dotcom bubble — January 1998 to December 2003; GFC — October 2007 to October 2010; COVID-19 crisis — December 2019 to December 2020.

[8] We have not extended analysis to the tech bubble due to limitations on manager data availability.

[9] We formed the sample of global developed equity income strategies by selecting those strategies in the MercerInsight global equity universe that are named “dividend,” ”income” or ”yield” and have a dividend focus in their investment processes. The sample excludes strategies for which we do not collect portfolio data. The sample also excludes passively managed and purely quantitative strategies that use simplistic quantitative screens focusing on yield.

[10] For the GFC, we have focused on calendar years 2008 and 2009. For the COVID-19 crisis, we have included data for Q1, Q2 and Q3 2020.

[11] Year-to-date is as of September 2020.

[12] 2008-2009 represents cumulative returns over this period. The global developed equity income sample size for the 2008 and 2009 analysis is 12 strategies.

[13] The sample size of global developed equity income in the chart is 30 strategies.

[14] Although we recognize this analysis only captures the past two crises in the global equity income space, to provide additional perspective, we also analyzed the performance of active UK income equity managers due to the strong income-paying heritage in this area of the market. (As illustrated by the Investment Association, which has a UK income universe that has been in existence since 1992 and now consists of more than 80 strategies.) The data show that UK active equity income strategies outperformed the FTSE 100 and the MSCI UK High Dividend Yield Index in 2008 and 2009 and during the first three quarters of 2020. 

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