2021 capped a grim decade for income-seekers. Even as companies started to pay dividends once again, equity income strategies remained deeply unfashionable. As markets have jumped between the ‘safety’ of megacap technology and recovery areas such as oil or banking, many solid dividend-paying companies have been stuck in the middle.

However, at a time when alternative income sources are thin on the ground, and investors need to work harder than ever to protect their portfolios against inflation, they may not be able to ignore the value in dividend strategies indefinitely. Over the past 12 months, dividends have bounced back. In the UK, for example, dividends rose 89.2% in the third quarter of 2021 to £34.9bn. A boom for mining companies and some one-off special dividends helped deliver this astonishing growth, but almost all sectors saw a rise in payouts.¹

This pattern has been replicated across the globe. In Europe, regulators lifted the restrictions on bank dividends, pushing payouts higher. Elsewhere, previously cautious companies have felt sufficiently optimistic on earnings and growth to resume dividends. For example, mining group BHP distributed $18.9bn USD to investors in 2021.²

However, in spite of this recovery, the equity income sector has still remained out of favour with investors. In the latest Investment Association statistics, the UK Equity Income and Global Equity Income sectors continue to shed assets as investors look elsewhere³. Many of the equity income investment trusts remain on significant discounts to the value of their underlying shareholdings.⁴

Change ahead?

However, there are a number of reasons why investors may start to look more closely at the sector. Inflation is likely to focus investor attention on ‘real’ income – that is, income after adjusting for inflation. Rising inflation erodes the purchasing power of fixed income assets such as bonds. Investors who want to ensure that their income can still buy as much as it did before need to look to the stock market. In this respect, dividends are appealing not just for their higher starting yields, but also because the income they offer can grow.

Equally, the valuations for many dividend paying companies have dropped. This means investors can pick up mature, well-established businesses paying a reliable growing dividend at relatively low cost. Ultimately, as markets become less focused on the interest rate environment and Covid, they may pay closer attention to these anomalies. Income strategies have been so out of favour that there wouldn’t need to be a significant change in sentiment for it to have a big impact in the market.

The right choices

Equity income isn’t a panacea. Investors still need to be selective about where they invest. Many of the old criticisms of dividend strategies – that they are focused on stodgy, mature businesses with little growth or that they lack diversification – could still be levelled at certain funds in the sector.

That said, at BlackRock, we would strongly disagree with the idea that dividend investors are condemned to low growth. It is vitally important to look beyond the world’s largest dividend payers, into smaller and medium sized companies where there is more growth. Equally, it is important to look across the globe, into emerging and frontier markets, for example, where economies may be in a different cycle, or where investors can access higher growth or new industries. This can help give equity income portfolios a different flavour.

Equally, investors need to lift the lid on companies: finding companies with pricing power, robust cash flow and the prospect of long-term growth is important in ensuring that dividend payments will keep pace with inflation. This is where our fund managers focus their efforts across all the BlackRock investment trust portfolios.

The investment trust advantage

A final point is that investment trusts have some advantages for dividend investors. Should sentiment towards the sector recover, investors may benefit from the narrowing of the discount as well as appreciation in the underlying shares (of course, the same may happen in reverse should detriment deteriorate).

Equally, investment trusts can reserve income in buoyant times to pay it out at times when dividends are tough. During the pandemic, many investment trusts drew on these reserves to maintain payouts to their shareholders. This helps create a more predictable income stream for investors. Finally, investment trusts can also use selective borrowing to enhance the income they pay.

Growth and income are not incompatible. Investors just need to be selective. The investment trust structure allows them to be flexible, unconstrained by size, by country or by sector in finding thriving companies that also pay an income to investors. As investors re-evaluate the sector, investment trusts are a fertile hunting ground.

For more information on BlackRock’s range of investment trusts, please visit www.blackrock.com/its

Sources:

¹Link Group, October 2021
²Financial Times, Nov 2021
³The Investment Association, Nov 2021
⁴Trustnet, Jan 2022 

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