Forging a way forward

UK dividends have been upended by the pandemic, yet they will bounce back. Income Fund managers Alan Dobbie and Carl Stick explain what they are doing to protect capital and build the foundation for a growing dividend.

Rathbone Income Fund Objectives
We aim to deliver an annual income that is in line with or better than that of the FTSE All-Share Index over any rolling three-year period. We also aim to increase the income we pay you in line with the Consumer Price Index (CPI) measure of inflation over any rolling five-year period.
We aim to generate a greater total return than the FTSE All-Share Index, after fees, over any five-year period. Total return means the return we receive from the value of our investments increasing (capital growth) plus the income we receive from our investments (dividend payments).
We use the FTSE All-Share Index as a target for our fund’s return and the income we pay because we want to offer you a better income and higher returns than the UK stock market. Increasing your income payments at least in line with the CPI measure of inflation protects your future spending power.
We also compare our fund against the Investment Association (IA) UK Equity Income sector because the funds in it are similar to ours.

For many of our investors, a real increase in the value of the income that they receive from us is a principal reason for owning our fund. A “pay-rise every year” has been a key strapline for our fund. Therefore it is very rare for us to cut our distribution. Indeed, prior to this year, our fund’s distribution has been increased in 25 of the last 26 years, a record of which we are very proud.

These are extraordinary times that demand extraordinary measures. If companies cannot operate, they cannot generate profits; and if profits are lower, they should cut their dividends to protect their businesses. And that affects the distribution that we can offer.

Such stringent cuts to the aggregate dividend income on offer from UK businesses mean that it is impractical to determine a realistic yield on the FTSE All-Share Index while the economic impact of the pandemic has yet to be fully understood. This yardstick has been removed temporarily by the Investment Association.

There is a sensible and pragmatic way forward. We want to avoid risking your capital by investing in weaker businesses in the search for yield whilst the economic environment is so uncertain. Because of this, the income that you receive may be less than the objective in the short term. While we’re loathe to make predictions, short term may mean the next six to 18 months, depending upon the longevity of the current crisis.

Our first priority is to preserve capital. We are looking through the current crisis, and investing in businesses that have a robust future on the other side. We focus on businesses that offer sustainable cash returns on investment, which means that they are the ones best able to grow profits, through the investment of their own cash into their own businesses, without diluting returns. If they continue to pay out a proportion of these earnings as dividends, they should generate increases in income that beat inflation.

Paying you an income that grows faster than inflation is powerful, for two reasons. First, it means the true value of your income – what you can buy with the distributions you receive – increases over time. And if you decide to reinvest this income, that helps boost the compounding of returns that Albert Einstein called the eighth wonder of the world. Second, companies that can steadily increase their dividends over time tend to be well managed, with reliable earnings and solid business models. We believe investors are better served by buying strong companies that are likely to increase their payments in the future than buying cheaper businesses with a higher yield (i.e. more income for your pound today) whose dividends could remain stagnant for years or even fall.

And our price discipline means that we endeavour to maximise our total returns by being disciplined on price, because there will be opportunities to buy some very good companies at very keen prices, if we are patient. Therefore, by buying well, not only can we enhance total returns, but we can proffer a dividend yield that is attractive to income hungry investors. But our emphasis will be on quality of dividend, rather than quantity, a discipline which we hope more businesses will adopt in the future.

Finally, we will continue to be judged against our peers, and our overall performance will be testament to the adherence to our process. There are many things outside of our control, but the way we go about our own business is down to us. And we will continue to update you with our plans over the coming months.

We wish you and your families the best of health through this crisis.

For more on why we are optimistic about the future of UK equity income, take a look at Carl’s blog here.

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