UK dividends have made a strong recovery since the pandemic, boosted by strong corporate earnings, a weak pound and high commodities prices. UK companies are set to pay an impressive £97.4bn in dividends in 2022. But can this strength last in 2023 in the face of high inflation, higher interest rates and a recession?

The recovery in UK dividends has been stronger than many dared hope in the midst of Covid-19. The pandemic also helped strengthen the dividend position of many UK companies. Prior to the pandemic, some of the largest companies had been over-paying, leaving payouts looking extremely stretched relative to earnings. The pandemic allowed them to re-set those dividends at a lower level, improving dividend cover (the extent to which dividends are covered by earnings) and creating a stronger outlook.

There have been other factors at work in the UK’s improving dividend picture. The commodities boom has helped oil and gas, and mining companies, which make up a significant proportion of the UK market. UK dividends have also benefited from a weaker currency because many UK companies have overseas revenues, which have been flattered by the conversion back into pounds.

Many of these elements are still in place. High dividend cover gives companies flexibility, allowing them to pay growing dividends. There is still strong support for some of the UK’s key sectors: rising interest rates favours the banking sector, for example, while the energy transition looks to provide long-term support for the mining sector. The pound may have recovered somewhat against the US Dollar, but it remains near historic lows.

However, recession now looks inescapable, which will make it more challenging for companies to deliver strong earnings, and may therefore put dividend growth at risk. While the outlook still appears strong for mining, oil and gas, or the banking sector, there are areas likely to be knocked by economic weakness – retail, for example.

At this juncture, we believe quality is particularly important. Higher quality companies – those with a strong competitive advantage, robust balance sheet, experienced management teams and healthy ESG characteristics – are in the best possible position to pass on higher input costs and sustain their earnings through any economic weakness. Companies need to ensure that pricing power is resilient: because they are embedded in their customers’ work flows, have a strong brand, or are good at innovation. In contrast, companies with a lot of debt are always vulnerable in this type of environment. We see markets starting to differentiate clearly on these factors.

Quality needs to be balanced with the need for a higher income stream. The best quality companies may not have the highest yields. At Murray Income Trust, we use option-writing to provide an additional income. This allows us to invest in high quality companies but with lower starting yields. As such, we can ‘trade’ some of the upside of an individual stock for a payment that is added to the income. It boosts the yield without adding to overall risk and allows us to invest in higher quality, but lower yielding companies. The trust also employs some gearing.

There are other factors to consider in delivering a strong and robust dividend stream for investors. Diversification is vital in an unpredictable climate. The market can change very quickly and we need to avoid over-reliance on an individual sector. For example, we have 15% of the portfolio in overseas listed companies, which is helpful in terms of diversifying risk in individual sectors, such as pharmaceuticals, while also providing access to companies and industries that can’t be found in the UK market - elevator company Kone, for example, or luxury goods company LVMH.

Robust research is also important. This is an environment likely to expose the smallest of weaknesses. At abrdn, we have a large global analyst team. This allows us to get under the skin of individual companies, understanding where the market may be misreading a company’s prospects and, importantly, allowing us to determine a fair price. Even the best company can be a bad investment if the price is too high.

We can also support the income on the trust through revenue reserves. The investment trust structure allows us to reserve revenue in good times to support the pay-outs to shareholders in more difficult times. We used this facility modestly during the pandemic - precisely the type of rainy day we’d been saving for.

Dividends are a vital part of Murray Income’s objectives. We understand that investors rely on the high and growing income we aim to provide. We’ve increased the dividend every year since 1973, qualifying the trust for ‘Dividend Hero’ status from the Association of Investment Companies. This is only achieved by being very careful about the quality of the companies in the portfolio, diversifying the yield and using the full powers of the investment trust structure.

Five year dividend table (p)

Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: Aberdeen Asset Managers Limited, Lipper and Morningstar.

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Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at Bow Bells House, 1 Bread Street, London, EC4M 9HH. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

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