David Goldman and Adam Avigdori, Co-Managers of the BlackRock Income and Growth Investment Trust plc, believe these are tough times for dividend seekers in the UK, but active management can help navigate this difficult environment.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
These have been uncertain times for those who need an income from their investments. Many companies have postponed or cancelled their dividend payouts in the wake of the COVID-19 outbreak. The economic outlook remains uncertain even as the immediate crisis has passed, with other issues such as US/China tensions and Brexit coming to the fore once again.
In general, the companies in our portfolio have been more resilient in their payouts than the market as a whole. Many have postponed dividends until their earnings situation is clearer, but we remain confident that many will return to the dividend list. Our focus on stock selection has significantly helped the resilience of the portfolio.
Free cash flow
For us, it is vitally important that a business is able to generate cash consistently over time. This dictates its ability to pay an attractive and growing dividend over the longer term. Inflation-beating dividend growth is best achieved from companies that are able to grow free cash flow.
If companies have high levels of free cash flow, they can reinvest back into the business, ensuring long-term growth. Too many companies in the UK market pay dividends at the expense of growth, or – worse still – from debt. We want to see companies investing for the future. This should not be incompatible with paying a dividend.
Dividends are a promise from companies, not an obligation. There needs to be a willingness to pay a growing dividend on the part of the management team. In the current environment, they also need to be allowed to pay. We are seeing this today in the financial sector, where banks and other companies have been prevented from making dividend payments, either because of government intervention or because they have taken government support.
Selectivity is vital. We want companies with strong barriers to entry, with something in the products and services they provide that differentiates them. This type of business has been able to maintain and grow its dividend, some of them even through the crisis. As it stands, we have a higher weighting in consumer goods and consumer services. We like companies that can compound cash flow over time, and this is an area where we find many stocks that meet our criteria.
This crisis and the dislocation in the market from the sell-off we saw in the first quarter provided us with significant opportunities to buy high quality franchises at lower valuations. Undoubtedly, some companies were hit hard by the crisis, but often raising additional funds has provided the balance sheet support they have needed to get them through this challenging period. The key, though, is to invest in those businesses with cyclical as opposed to structural problems; the former is likely to survive and could produce accretive returns for the portfolio, the latter will not.
More recently, the Board took the decision to allow up to 5% of the trust to be invested in companies listed outside the UK. There is a multitude of reasons why we proposed to invest in international equities. Firstly, it allows us to access attractive themes unavailable in the UK, to invest in more attractive international competitors than their UK peers, as well to benefit from other yield enhancers for the income of the portfolio.
Environmental, social and corporate governance (ESG)
Sustainability is a crucial consideration for us. We believe that ESG factors and practices are intrinsic to a company’s long-term profitability, cash generation and risk profile. Our fundamental research incorporates our assessment of ESG factors and trends, such as decarbonisation, as well as the risks and opportunities that result from a company’s ESG practices. Our search for sustainable free cash flow leads us to companies that account for ESG trends when allocating capital, promote sustainable relationships with all their stakeholders and operate with clear processes to mitigate risks.
One big certainty for us is that post this crisis, the role and importance of ESG will be enhanced. Already in meetings, and as a team, we have been in contact with approximately 760 companies year-to-date, management and boards are far more aware of their role in society and their ability to affect change. Even for those significantly financially impaired like Whitbread are still embracing good behaviours by opening up their empty hotels to house essential workers and NHS staff. Unilever has committed a huge financial package of nearly US $500m in goods and cash to help deliver essential items to places where it is needed most. They have also brought forward all their payments to small or medium-sized enterprises (SMEs) to help them with working capital. We expect that this crisis will deepen the corporate world’s role in their employees’ lives, in their communities and in society.
Investment trust structure
The investment trust structure adds flexibility in a crisis. For example, we have used gearing – borrowing to invest – effectively during this crisis. We took gearing lower in early 2020 because we were worried about market valuations, but have since pushed it up to 4-5%, which may help with both dividend and capital growth.
The Board is committed to using the Trust’s reserves to support dividends to shareholders. The Trust has one of the strongest reserves in equity income sector. We have built this over time to ensure that we can sustain payouts to our shareholders during difficult times, just like the one we are experiencing today.
Risk: Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. Unless otherwise stated all data is sourced from BlackRock as at July 2020.
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Trust Specific Risks
Liquidity risk: The Fund’s investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
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