HL Select UK Income Shares – Dividend Reduction

Steve Clayton - Fund Manager

14 May 2020

With businesses and economies locked-down in much of the world, many companies are facing severe pressure on their profitability and cash reserves. In the banking sector, regulators have instructed UK banks to preserve their capital and refrain from making dividend payments to investors. A substantial proportion of UK companies have now either cut or scrapped their dividends altogether. As always, dividends are variable and not guaranteed, and this is sadly truer today than at any time in my 30+ year career in the markets.

Even Royal Dutch Shell, famous for having held or raised its dividend every year since WW2 has slashed its quarterly payment, reflecting a collapse in energy demand as cars sit still and aircraft remain grounded.

The HL Select UK Income Shares fund has seen some companies pay the expected levels of dividend and some that have cut or cancelled payouts. Primary Health Properties (PHP) earns its monies from rents due from the Health Centres it owns. These are largely paid by the UK and Irish health services and this has given PHP a very secure flow of income. Allowing it to continue making dividend payments.

At the other end of the scale, Persimmon went as far as scrapping a dividend that had already been announced and gone ex-dividend in the market. Persimmon’s income largely comes from private citizens’ house purchases, which have slowed to a trickle.

How do we decide the fund’s dividend payout?

Each financial year, investors are paid all of the income that the fund receives from its investments. But we decide how much to pay out in any given month, so each year investors receive 11 monthly payments that we the managers have decided and then in month twelve the dividend consists of everything left over. The fund’s financial year runs to the end of September, so that final balancing payment is paid to investors in late October.

Persimmon’s decision to scrap its dividends and the cut in payments by Royal Dutch Shell will reduce the fund’s income, as will the lack of dividends from our bank shares. Since the virus struck we have focused on bolstering the defensive positions within the fund and taking some money off lower yielding positions where we could see risks rising in the longer term too. So the size of our Unilever holding was increased, but we sold out of Rightmove altogether, due to its low yield and the risk that the size of its market may shrink longer term if, as we expect, estate agents close their weaker branches.

Our positions have been chosen for their longer term potential and once the virus is no longer holding economies back, we expect them to prosper once more. Indeed, we can see reasons why businesses like GB Group may see their prospects boosted longer term by the virus, since anything that boosts online shopping helps bolster demand for their ID and Address verification services.

So we are not making wholesale changes to the portfolio, but do recognise that the level of certainty about the portfolio’s income in the next few months is much reduced. Having looked at the level of income expected in the second half of the fund’s financial year we have taken the difficult decision to reduce the monthly dividend declared for April, (paid in late May), by 50%.

That level of dividend should be sustainable even under what we would regard as a “worst case” scenario. The final dividend for the year would be lower than a year before, but still better than this newly reduced level of regular monthly payment.

Managing the dividend moving forward

There are a number of key decisions that our portfolio companies will be making in the weeks and months ahead that will impact the fund’s income. Our insurance holdings are important here. All three have made statements supportive of their ongoing ability and intent to pay dividends. But we do not want to create hostages to fortune by assuming all will be fine when uncertainty remains high.

We will review the level of dividend each month, taking account of new information as it arises. Our setting of the April dividend has been deliberately cautious. We are sorry if this causes difficulties for any investors. If key holdings within the fund do indeed maintain their dividend levels then the outlook for future payments will improve.

Looking longer term, we expect that most companies that have cut or scrapped their payouts will return to paying dividends in time. At this stage our thoughts are that most companies that have reduced their payouts this year will likely not reinstate them until late into the fund’s 2021 financial year at the earliest.

We will keep our investors up to date with our expectations for future dividend levels in the months ahead.