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Vodafone's dividend cut: lessons for investors

01 August 2019

5 minute read

Following Vodafone’s decision to slash its dividend earlier this year, we consider how investing in a fund can reduce the risk of being caught out by a single company’s dividend policy change.

Who's it for? Confident investors

The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

What you’ll learn:

  • What went wrong at Vodafone.
  • How to reduce risk through investing in a fund.
  • Our selection of UK equity income funds on the Barclays Funds List.

UK dividends reached record levels in the second quarter of 2019, but investors in Vodafone have little reason to celebrate after seeing their dividend slashed by 40% in May.1

Companies paid out £37.8 billion over the quarter, according to the Link Group Dividend Monitor, although this amount was boosted by a number of exceptionally large special dividends.2

Here, we look at some of the reasons behind Vodafone’s first dividend cut and explain why it’s vital not to rely too heavily on just one or a few companies if you’re seeking a regular income from your investments.

A healthy dividend history

In 2018, WPP, the world’s largest advertising company, ranked Vodafone as the most valuable brand in the UK. When it comes to searching for income in UK equities, investors have flocked to Vodafone on the back of its high and sustainable dividend. But the telecoms market is changing and it could well be that investors will need to adapt too.

To preserve its position as a leading telecommunications company, Vodafone must continually invest in its infrastructure, including spending vast sums of money for the future 5G network

Gerard Kleisterlee, chairman of Vodafone, said the board had “worked hard over a number of years to support the dividend but, given the external challenges to our business, the board and I felt that a cut was unavoidable”.

He added: “We are very sorry that your income has been reduced and the decision to cut the dividend was not taken lightly. But we are convinced that this was the right thing to do for the long-term future of the business.”3

Vodafone has always been a stalwart for investors seeking income and for nearly 20 years the company paid a healthy dividend to its shareholders. Even throughout the financial crisis, a time when high-yielding sectors such as banks were busy cutting their dividends, Vodafone provided consistent dividend growth to investors.

The telecoms industry has always generated cash and when Nick Read joined Vodafone in 2016 as the new chief executive he made a commitment to keep up its dividend payments. However, to preserve its position as a leading telecommunications company, Vodafone must continually invest in its infrastructure, including spending vast sums of money for the future 5G network. It’s an expensive business to be in!

At the beginning of this year, total debt sat at £27 billion, which is about the same as the total value of the company. Vodafone was finding it increasingly difficult to maintain its dividend and pay the interest on its debt. Something had to change, and that change was to cut the dividend by 40%. Although this came as bitter disappointment to investors, the company can now focus on reducing its debt and becoming stronger.

There are other companies out there which are paying healthy dividends but they too come with their own set of risks. For example, the shares of global mining conglomerate Rio Tinto currently yield around 5%, but the business operates in a market that demands high capital expenditure and their earnings are dependent on the market price of the commodities they dig out of the ground.

Reducing risk with a fund

What lessons can investors learn from Vodafone’s dividend cut?

Relying on just one or a couple of companies to provide regular dividends is a very risky approach as, whatever their track record, there are no guarantees that they will continue to provide dividend income in years to come. The level of dividends that a company pays ultimately depends on the profits that it makes and these can fall.

Finding a good fund manager who has consistently delivered in the past over the long term and diversifies across multiple companies can reduce the risk of being caught out by one single dividend policy change.

UK equity income funds focus on investing in a wide number of companies paying high or growing dividends, helping spread risk. Fund managers are supported by a team of analysts who spend their time and expertise looking for companies which not only pay dividends but have the ability to maintain and even increase them over time.

Remember, however, that there are no guarantees that dividend growth will continue for any fund, and   like the value of the underlying investments that produce them, dividends can fall as well as rise. Also, bear in mind that a manager’s past record of securing dividend income is not a reliable indicator of future performance.

Finding a good fund manager who has consistently delivered in the past over the long term and diversifies across multiple companies can reduce the risk of being caught out by one single dividend policy change

Clive Beagles, Fund Manager of the JO Hambro UK Equity Income Fund says, “It’s a considerable responsibility but we believe a good active fund manager can add value over the long term by managing a portfolio of shares and understanding the risks involved.”

Commenting on Vodafone in particular, Clive says, “Market worries about a possible cut to Vodafone’s dividend had been casting a shadow over the company’s share price for some time. We believe the CEO is doing the right thing by cutting costs, promoting efficiencies and sharing infrastructure with other telecoms operators, which helps lower Vodafone’s network expenditure costs. However, the fund invests in over 60 companies, so we are not reliant on the dividend policy of just one business.”

Other funds that invest in the UK and focus on the companies that are paying high and growing dividends include the Man GLG UK Income Fund (income units) and the Artemis Income Fund (income units), which can be found on the Barclays Funds List alongside the JO Hambro UK Equity Income Fund (income units).

These funds are selected by Barclays investment specialists and, based on our research, they’re the funds that we believe have the potential to generate consistent returns over the medium to long term.

These funds are designed for the long term so you should only consider them if you can stay invested for at least five years.

All these investments can fall in value as well rise; you may get back less than you invest.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice.

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