Industry Insights: Investing for Income? How to maintain a post Covid-19 income stream

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Industry Insights Series Q2 2020
Gerry Caley, Senior Partner


In recent blogs we have highlighted the importance of having financially strong companies in our fund portfolios. These are companies with good reserves and adequate dividend cover. We also discussed the importance of portfolio diversification. But what happens when the markets are affected by a global event such as Covid-19? How do we help to safeguard a regular income stream for clients who rely on it?

One of the ways we achieve this is to ensure that a portfolio is not wholly reliant on UK Equity Income funds to provide the dividend distribution (yield). UK stocks tend to generate higher returns than countries such as the US, however there are other areas of the world that also generate high yields in comparison. For example, companies in the Asia Pacific region are well positioned to take up some of the shortfall we may suffer in the UK.  

Back in the late 90’s several booming economies in Southeast Asia, known as ‘tiger economies’, suffered badly and market recovery was slow. There was little formal legislation around dividends at the time, but afterwards we witnessed a gradual culture change across the regions. Many CEO’s and boards began to adopt a more proactive approach to paying dividends. There was improved governance over business processes in the interest of the external shareholders, and over time this resulted in increased trust of these Asian companies with the outcome being increased investment from external shareholders – many being UK based fund managers. 

Today, the Asia Pacific region is home to roughly two thirds of the world’s population. Although the trend is towards an ageing population in some parts, a large working-age population underpins the growing economies. This also brings rapidly increasing wealth, and today this region probably has more high net worth individuals than any other. All of this helps to maintain good GDP growth, which outstrips the western countries. 

Whilst the Asia Pacific region was the first to be affected by Covid-19, it is not by luck that they emerged first or more quickly than other countries or regions. They were generally quick to contain the virus and quicker to reopen their economies, therefore suffering less economic damage. Although their dividends will be affected, it appears likely that they will be reduced to a lesser degree – approximately 25% compared to 50% in the UK, or in the case of banks, no reduction at all.  

In terms of our portfolios, we always have a percentage of good growth funds - even if we are building an income stream. Some of these funds will probably pay a small dividend of around 1-3% which is helpful, but we would mainly be looking for capital growth. This allows us to maintain the necessary capital and provide the extra income. Additionally, by running our client portfolios on a suitable platform, we can shave profits off better performing growth funds to top up the cash account, thereby funding the distribution.  

And so, by combining our knowledge of building flexible portfolios with the strong relationships we build and maintain with a wide range of investment houses and fund managers, we are better able to service the needs of our clients. 

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Industry Insights: Active Fund Management

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Industry Insights Series Q2 2020
Alex Macdonald, Financial Adviser

Here at GDA Financial Partners, we are big believers in active fund management, as opposed to passive fund management and this blog sets why we hold these views.

Passive fund management

This centres around reducing the cost of investing and on the face of it appears to be appealing, but this is achieved by eliminating fund managers, investment research professionals and having no contact with the companies in which you invest!

A passive fund will be ‘benchmarked’ to an index, with stocks selected according to their size relative to the index (e.g. if BP’s market capitalisation is 6% of the FTSE100, then the passive fund will hold 6% of BP, irrespective of quality or the attractiveness of the share price).

This approach can be likened to investing in ‘the good, the bad and the ugly’, as there is no attempt to differentiate each stock by taking factors such as value (is the share over-priced), sales growth, debt, dividend growth and recurring income streams, to mention only a few.

The FTSE100 Index is particularly vulnerable to passive fund under-performance, having six major banks, two huge oil companies, four utility companies and eight mining stocks, to name but a few of the sectors which the prudent investor would currently wish to avoid.

A passive fund can only attempt to match the performance of the index, never beat it and after the paying the fund annual management charge, always under-performs the index!

Active fund management

This involves employing a fund manager (sometimes a pair or team) who look at each stock on its merits within the given area the fund invests (e.g. Europe or UK large cap stocks), assessing the share’s growth prospects, whether it can be purchased at an attractive price and taking into account the following factors:

1. Is the current dividend well covered by reserves?
2. How likely is it that the dividend will be cut (this would depress the share price and reduce future dividend income, a double whammy and is a big concern at present with companies’ finances under severe pressure due to Covid 19)?
3. Are debt levels too high (such companies fare badly in recessions or downturns)?
4. Is company news flow positive or negative?
5. Are there taxation policies or impending legislation which would affect the future share price (e.g. a profits tax, mis-selling fines or compensation)? 

As you can see from these points, investing in a company without researching any of the above matters can only be deemed a gamble.

Obviously there are good, mediocre and bad active fund managers and our job as advisers is to recommend managers whose track record speaks for itself and we look for consistent out-performance of the sector average over the medium term, as this demonstrates that the stock selection process used is effective.

Preventing loss of capital by using active fund managers is important, as the following example shows: 

Say a fund has a value of £1000 and the market falls by 25%, it is now worth £750. To get back to £1000 requires a gain of 33% (£250/£750 x 100) and this may take several years! 

Far better not to lose 25% in the first place! 

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Industry Insights: Pension contributions for furloughed workers

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Industry Insights Series Q2 2020

Jessica Amodio, Financial Adviser

As an employee, your employer may have had to furlough you as part of the business response to the coronavirus crisis. Being furloughed means that your employer keeps you on the payroll while they are unable to operate or have no work for you to do because of coronavirus. This allows your employer to access funding from the Government via the Job Retention Scheme which covers 80% of an employee’s regular month wage or £2,500 (whichever is lower). The funding also covers both the employer National Insurance Contributions and minimum automatic enrolment contributions. 

What being furloughed means for auto enrolment pensions 

From 6 April 2019 the minimum total contribution is 8% of qualifying earnings. The employer must pay 3%, the employee must pay 5%, and the government adds tax relief of 1%. As part of the Job Retention Scheme, the government will pay the auto enrolment minimum employer pension contribution which is 3%. This is based on the 80% adjusted furloughed salary or £2,500 per month if lower. You will need to continue paying your 5% contribution to get the Government’s addition.  Your own pension contributions and your employer’s pension contributions will continue as normal unless told otherwise.  

If you are struggling with cashflow then there may be the option to reduce contributions, suspend contributions, or opt out of the plan altogether. Any of these options require careful consideration as they could have a massive impact on the value of your pension savings when you come to retire.  

It is worth noting that if your employer pays above the statutory minimum pension contribution, the Government will not cover anything over the standard 3%. If your employer wishes to continue paying an increased contribution, then the difference will need to be funded by themselves.  

In addition, some people have an arrangement with the employer that they will continue paying 100% of normal salary, rather than 80% from the Government. In these cases, the pension contribution which is claimed from the Government will be calculated using the furloughed salary rather than the normal salary.  

What being furloughed means for defined benefit pensions 

Defined benefit pensions provide a guaranteed income for life after retirement and are therefore regarded as the safest and most generous pensions available. In the private sector they are virtually all closed to new contributions, and those in the public sector are backed by the taxpayer. The government has not specifically mentioned defined benefit schemes, so it is unclear what impact furloughing will have on them. It is anticipated that they will follow the same rules as above, and contributions will remain unchanged unless otherwise stated.  

If you have any questions regarding your pension, please do contact your adviser who will be happy to speak to you and go through any options that may be available. 

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