Equity investors should not rely on dividend yields alone, which becomes particularly important at a time of the looming dividend cuts, and equity income strategies should be more ‘yield agnostic’, according to First Sentier Investors.
Such strategies would focus on earnings which would drive long-term income and this would underpin dividend returns. This would help investors not to worry about companies cutting dividends in the near-term as long as they could still generate long-term income.
“A retiree’s world is all about long-term income defined as dollars, yet income strategies often focus on yield percentages: a short-term concept focused on the current year's dividends compared to the current share price. Then, when dividends are reduced significantly, it can create a lot of stress for investors who rely on that income for their lifestyle,” First Sentier’s head of equity income, Rudi Minbatiwala, said.
“I would argue that some companies’ payout ratios have been too high. Now, they are motivated to hold back dividends to strengthen their balance sheets. It’s an opportunity to reset dividends to more appropriate level – especially in the context of greater uncertainty.”
The equity income strategy would also make use of equity options to boost short term income and help manage returns through volatile times.
According to Minbatiwala, income investors were generally seeking a smoother return path than what the equities market delivers.
“One way to think about it is that you don’t want volatility, so we sell some of it and convert it into an income stream, with the options income providing a cushion from the falling market. The other advantage is that it removes the handcuffs from a narrowly defined universe of only high-yield stocks, which are often in the same sectors and exposed to the same risks,” he added.
“Income investors are often retired and therefore focused on capital preservation. Yet investing in a narrow universe of high yield stocks does not provide sufficient diversification and protection from significant market declines, as many nervous investors noted in March and April. When this is coupled with smaller dividend pay-outs, it can really keep people up at night.”