Moves by regulators to encourage financial institutions to retain capital, coupled with lower earnings across most sectors, may have far-reaching implications for retirees, companies and investment managers this year and beyond, a research paper by Realindex argues.

The systematic equities manager looked at the impact of several themes affecting dividends in the current market in a research paper. In particular, it considered the way central banks and regulators around the world have initiated policies in an attempt to constrain dividend payments by financial institutions.

In a bid to shore up capital and maintain liquidity, for example, APRA released a guidance note on April 7, 2020 recommending banks and insurers defer, reduce or cancel dividends, without specifying a time period. ANZ & Westpac Bank’s decision to defer, and NAB’s move to reduce, interim dividends suggests institutions are complying. 

This may have a notable impact on markets. Realindex’s modelling suggests that 60% of the ASX 200 benchmark’s total return is due to dividends and for Financials, that rises to more than 70% of the total return (including dividends and buybacks).

The research paper’s author, Dr David Walsh, Realindex’s Head of Investments, said moves to limit dividends could both reduce investor incomes and affect valuations.

“We know that dividend payments are an important component of returns to shareholders, especially retirees. They are also the chief source of franking credits in Australia, and so they are a key part of the attraction for investors.

“The potential enforced cancellation of dividends for certain financial institutions will not only reduce the income investors are expecting, they will likely look to move capital to companies that do pay dividends. This could drive up the prices of stocks such as Telstra, Wesfarmers or Coles.”

Such forced reductions are likely to come at the same time as lower earnings in other sectors put dividends at risk. Modeling of the Realindex portfolio shows that at the end of April, the weighted average consensus of Dividend per Shares downgrades was -25% for Australia and -17.3% globally, with downward revisions led by energy, transport and banks.

“The extent of dividend cancellation or withdrawal is not clear yet, but many dividend forecast downgrades have already appeared in analyst forecasts and there are some sectors that look quite at-risk.

“We expect dividends in Australia to be more severely impacted from Covid-19 than other developed markets. A decline in aggregate demand from China is likely to affect earnings in the Materials sector, at least in the short term. Our modelling also shows Real Estate – especially retail – is at risk of distress.

“Additionally, the low oil price will test the resilience of many energy companies, and we assume that this will lead to dividends being at risk, especially for global portfolios,” Dr Walsh said.

The paper also notes that corporate behaviour can be driven by investor demand for dividends.

“Dividends act as a signalling mechanism for firms. Strong consistent dividend payout ratios and payments are a way for investors to understand the confidence that management has in the business. In addition, companies that cater to the demands of investors by paying dividends can attract a premium for their shares. Significant changes to this behavior could see changes in valuations going forward,” Dr Walsh said.

A changed dividend landscape could affect investment managers too, he added.

“Many investment processes rely on dividends as a key measure of company performance. This could be through core company metrics, like those used by Realindex, or more widely through dividend yield and dividend futures. We are in the process of analysing whether we need to amend our normal processes in light of current market conditions. I expect other managers will be doing the same,” Dr Walsh said.

Overall, the impact of these trends will depends on the length of the crisis.

“A critical point is that it is not clear how long this change will continue for. If it is a temporary change, many investment processes and market and corporate behaviour will probably not move markedly when averaged over a longer period. However, if this represents a longer term change or permanent shift, then the implications may be very different. Only time will tell,” Dr Walsh concluded.

Appendix: The chart below shows total dividends (net) paid by companies in Australia in the Realindex Australian equity model, split by sector for the last five years, ending on the 31st of March 2020.

Source: Realindex, Factset as at 31 March 2020