Dividend cuts no big deal for institutional investors

Institutional investors, like mutual fund companies and asset managers, generally aren't perturbed that a trend of dividend cuts or suspensions will emerge, crimping investment portfolios' returns. Diversification is always seen as a prudential investment strategy in a volatile market environment.

Share prices of United Kingdom-based banking giants HSBC Holdings and Standard Chartered took a dive in April when they shocked the financial market by scrapping dividends and ruling out any share buyback this year after the UK central bank told them to preserve cash by putting dividend payouts on the back burner as the coronavirus pandemic roiled global economies.

Although both banks are based in London, much of their revenue comes from Asia. They're among other UK lenders that have decided to suspend dividends as part of a coordinated response to a request by the Prudential Regulation Authority - a regulatory arm of the Bank of England.

New York-based investment bank Goldman Sachs said it expects dividends of S&P 500 companies in the US to retreat 25 percent from 2019 because of suspensions, cuts and eliminations by companies this year. It took note of recently launched stimulus programs among US bar companies seeking relief from forking out dividends or buying back shares until a year after they've repaid any government-sponsored loans.

Retail investors in Hong Kong aren't happy with HSBC's move as they are heavily reliant on the bank's four dividends per year to generate investment returns.

The case for institutional investors is even clearer. Mutual fund and insurance companies, as well as asset managers, invest heavily in high-dividend-paying stocks so as to secure a regular pile of cash to generate returns for clients.

HSBC's move to do away with dividends would mean Ping An Insurance (Group) Co of China will lose an estimated HK$5.6 billion ($723 million) in dividend income as the Chinese mainland insurer is the bank's second-biggest share owner, with a 7 percent stake.

"HSBC is one of the long-term investments in Ping An's equity investment portfolio. We'll continue to monitor related developments," a Ping An Group spokesperson said in reply to China Daily's inquiry as to whether HSBC's dividend cut would affect the insurance giant's investment performance.

The HSBC dividend-cut incident also ignited a clamor in the Hong Kong financial market that the UK-based bank should relocate its headquarters back to Hong Kong. The bank had moved its headquarters to London when it completed its acquisition of Midland Bank in the UK in 1993.

The reason being cited is that HSBC should be responsible to shareholders in the dividend payout decision when its bulk of revenues are generated in Hong Kong, rather than to be subjected to the UK financial regulator, which is far from the city. However, the UK-based bank said currently there are "no plans" to reconsider the bank's domicile.

Meanwhile, US-based Morgan Stanley sees the impact on Ping An's earnings, dividends and asset position as limited.

While dividend income loss will erode Ping An's net yield by some 11 basis points, the loss will be shared by policyholders and shareholders. HSBC's stock had lost 31 percent as of April 2, forcing Ping An's book value and available capital down by 1 percent and 0.5 percent respectively, according to Morgan Stanley estimates.

Institutional investors told China Daily they're not ruffled by recent dividend cuts by some listed companies that would hit their investment returns. This is because equity is a long duration asset, and a single year's dividend isn't a major part of the intrinsic value of a business.

In an environment where indiscriminate selling is producing huge dislocations to valuations, being able to identify well-run and well-capitalized companies is key as they're likely to emerge in a position of relative strength on the other side of the crisis. Indeed, they're firms with the strongest balance sheets and best positioned to resist pressure on dividends.

Asian dividend stocks have outperformed the broader region after previous selloffs, and many big companies in the region have been steady dividend payers through previous rounds of market turbulence, including firms like Taiwan-based chipmaker TSMC, global utility services provider CK Infrastructure, Hong Kong-based developer Sun Hung Kai Properties, and Chinese mainland-based conglomerate Guangdong Investment, according to Fidelity International.

During the 2008 global financial crisis, dividends were cut by more than 20 percent on average - a figure likely to be more than doubled in this downturn - Fidelity warned.

Manulife Investment Management - the asset management arm of Canada-based insurer Manulife Financial Corp - is using its "global multi-asset diversified income" strategy to generate returns from fixed-income coupon payments and options premiums, not necessarily equity dividends. It has invested in globally diversified income sources; for example, approximately 200 fixed-income names paying a coupon and 60 equity names paying a dividend. The options strategy embedded alongside goes further to enhancing that yield.

Diversified income

"We'll search for diversified and, where possible, uncorrelated income sources - coupons, options premiums or dividends," said Paul Kalogirou, managing director and multi-asset client portfolio manager at Manulife Investment Management.

"Our strategy is exposure to sustainable high-yielding, income-generating securities while minimizing exposing investors to outsize risk. We'll manage the investment risk by enhancing yields by picking defensive business models with an improving credit outlook, stable business models with relatively transparent cash flow, and corporations with government support," Kalogirou said.

Hong Kong-based mutual fund company Value Partners Group said dividend cuts or suspensions will not affect its new launches in high-dividend equity funds because the group's overall portfolio dividend yield is close to 5 percent, which is still very attractive in view of the current low-interest-rate environment.

The mutual fund company, which had launched its Value Partners Classic Fund and Value Partners High-Dividend Stocks Fund, does not invest in shares of HSBC and Standard Chartered in its high-dividend strategy portfolios.

Value Partners Group said the HSBC and Standard Chartered dividend scrap definitively will not affect its ability to pay investment returns on clients' high-dividend equity funds because very few companies in their fund portfolios are cutting dividends.

It believes the dividend scrap will not become a common trend as the HSBC and Standard Chartered cases will be specific only when both lenders respond to UK regulators, instead of a management decision to suspend dividends.

Whether the dividend cuts will emerge as a trend will highly depend on the economic drag from COVID-19.

"However, a potentially more serious issue is the impact of COVID-19 on an individual company's earnings and cash flow. The longer this drags on, the higher the risk that companies might conserve cash and hence cut dividends," Value Partners Group Senior Investment Director Norman Ho said.

"We have to pick stocks very carefully, based on key selection criteria, such as resilient earnings and cash flow, a strong balance sheet, as well as a not-too-excessive dividend payout ratio. It can be summarized as the 'ability to pay', plus the 'willingness to pay'," he said.