Dividend cuts prompt investors to rummage in junk for income
A steady erosion of stock market dividends is driving investors into Europe’s high-yield debt market, according to a report from Bank of America that predicts another strong quarter of fundraising for low-rated issuers.
Scores of big companies including BT and Shell have cancelled or cut dividends to preserve cash during the pandemic, leaving many investors looking elsewhere for income.
The dividend yield on the Stoxx Europe 600 index — which measures the expected payouts by the region’s biggest listed companies over the next year, as a proportion of their share price — has dropped to about 3.13 per cent, from 3.45 per cent at the turn of the year.
Many investors were now turning instead to riskier corners of the credit market, BofA’s European credit strategists said in a note on Monday. In the European industrials sector, for example, bonds offer yields 4 percentage points higher than the expected dividend yields on industrial equities.
High yield, or “junk” debt, “stands tall in a world where traditional sources of income are being depleted”, the analysts wrote.
That interest from investors is likely to mean that the second half of the year builds on a second quarter “for the ages”, BofA said. European high-yield bonds delivered a total return of 12 per cent during the period, as funding costs for all manner of issuers dropped.
Trevor Greetham, head of multi-asset at Royal London Asset Management, said he had stuck with an overweight position in global high-yield bonds as a “muddle-through investment”, while he saw risks ahead for equities. Rather than chasing income, Mr Greetham said his preference reflected bullishness on the sector given policymakers’ eagerness to support borrowers.
“Just as the banks were too big to fail in 2008, the credit markets were too big to fail in 2020,” he added.
Government and central bank interventions have favoured debt holders over equity owners, said Fraser Lundie, head of credit at the international business of Federated Hermes.
There have been “unprecedented levels of support actively ensuring that bondholders, even high-yield rated bondholders, are paid,” he said.
In the US there were significant flows into junk bonds after the Federal Reserve surprised markets in April by pledging to support the debt by buying exchange traded funds. While policy support in Europe has been less dramatic, BofA said that various state-backed lending programmes, along with ultra-low interest rates, had helped many issuers.
“We find evidence that the stunning drop in distress across some high-yield sectors goes hand-in-hand with their take-up of state-backed loans. And we believe there is more to come on this front,” the strategists said.
Investors and analysts will be closely watching economic data through the coming quarter for signs of a rapid recovery. BofA said it was expecting “plenty of positive data surprises” as countries reopen their economies, which they said was “an essential ingredient for leveraged credit to perform”.
While the rebound is likely to be a “mechanical bounce” in the data, given the scale of the economic collapse in Europe in the first half of the year, the strategists said they still expected the market to welcome bright signals.
Still, some strategists have warned that market sentiment is delicate as investors eye an uptick in Covid-19 cases in several countries including the US.
JPMorgan’s European credit strategists said in a recent note that they expected investment-grade and high-yield issuance to fade into a summer lull in the coming weeks. “The second half of the year will be much quieter in general, with most issuers already having raised substantial precautionary liquidity cushions,” the strategists wrote.