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Dividends, the sum of money paid regularly by a company to its shareholders, are under threat. And not just at the struggling, state-owned banks - Wolseley, Kingfisher, ITV, Rentokil, Friends Provident and Lonmin are just a few of the companies that have cut or even scrapped their dividends this year.
Many more are likely to follow suit: Neil Cumming, fund manager at PSigma, thinks even some companies that can afford to pay may look at their lowly share prices and high dividend yields and question whether they need to maintain their payouts given the climate of austerity. Overall, dividends are likely to fall by as much as 20 per cent next year.
That is bad news for the millions of investors in UK equity income funds, which rely on dividend payments and have already had a torrid 12 months. The average income fund has lost more than 30 per cent over the past year and the worst has all but halved.
Most vulnerable are those funds with heavy exposure to the banks, which used to account for around 30 per cent of total dividends in the stock market and much of its annual growth. This year, just two of the British banks - HSBC and Standard Chartered - will be paying any cash dividends, and Royal Bank of Scotland is unlikely to resume payments until 2010 at the earliest.
Brian Dennehy, managing director of independent adviser Dennehy Weller, has started a 'dividend watch' monitor analysing the payouts of equity income funds, which shows that five of the 10 funds which announced their dividends in November cut their payouts. He thinks that monitoring these payouts - which, he says, is 'very hard' to do - will be particularly important in 2009 as the economy slows.
But that does not mean equity investors should write off equity income funds completely. While stock markets are likely to remain volatile for some time, those companies that can pay a secure dividend - and even increase it - will be most resilient in the short term, and bounce back most strongly when the recovery finally comes.
Ian Lance, a fund manager with Schroders, points out that the income on the highest-yielding companies is better than it has been for 20 years and is higher than the return on UK gilts (government bonds that are currently much in demand). While he admits there will be cuts, he adds: 'Some businesses that have cut their dividends look very attractively valued when compared with their long-run earnings power, and returns in these situations are likely to come through capital appreciation [of the share price] rather than income.'
Tony Nutt, manager of Jupiter Income, thinks the rise in the dollar will have a big impact. Some of the biggest and most generous dividend-payers in the FTSE 100 pay in the US currency, including BP, Shell, HSBC, Rio Tinto and AstraZeneca. He points out that the decline in sterling relative to the dollar means that UK investors in SABMiller, for example, will enjoy a 35 per cent rise in their payout even if the brewer just holds its dividend, while BP - which is committed to increasing its payout - has had its best performance, relative to the rest of the market, in 35 years partly because of its dollar dividends.
Nutt adds that some income funds are also looking at riskier corporate bonds - where yields have soared on fears of widespread company defaults - as an alternative source of income. Jupiter's Distribution fund, which normally has 40 to 60 per cent in equities, currently has just 23 per cent in shares and the rest in bonds.
Richard Hughes, a UK equity income manager at M&G, points out that there are also plenty of companies increasing their dividends: Stagecoach recently raised its payout by a third; Thomas Cook, Tui and Compass were among those increasing dividends by 10 per cent or more; and many small companies are also enjoying robust growth. He adds that some companies in bombed-out sectors - such as Halfords and Morrisons in retail - are still managing decent dividend growth. Conversely, dividends are under threat in some supposedly robust sectors: resources company Lonmin has already cut its payout, while Rio Tinto warned last week that its will only be held.
Jeremy Lang, manager of Liontrust First Income, points out that more than 150 stocks with a market value of £100m or more yield at least 2 per cent more than gilts, giving him confidence that he can 'at least maintain if not grow the dividend' of his fund next year. He is focusing on two types of stocks. Firstly, robust businesses with strong balance sheets, many of which have global franchises that will be around in five years' time, such as Vodafone, BP and BAT. 'Second, are cyclical stocks that face near-term difficulties but will still be operating in five years' time, such as retailers and good-quality engineers which have been sold aggressively on fears of a recession.' These are firms such as M&S and GKN.
Darius McDermott, managing director of Chelsea Financial Services, says that income investors should not confine themselves to the UK but should also consider some of the growing number of overseas income funds. He particularly likes Argonaut European Income, Newton Global Higher Income, Sarasin International Equity Income and Jupiter European Income.
While European banks have been cutting dividends and seeking government support in the same way as their British counterparts, the outlook for European dividends in other sectors looks healthier than in the UK. Oliver Russ, manager of Argonaut European, points out that there are more than three times as many companies with a yield of 3.5 per cent or more in Europe than in the UK: 'Even if there are cuts, there is always somewhere else to go.'
Back in the UK, Ben Yearsley at financial advisers Hargreaves Lansdown thinks the Invesco Perpetual and Jupiter equity income funds are a good bet, as well as Artemis Income and PSigma Income. While there is no rush to buy in the current market, with bank savings rates set to plummet even further, a regular drip-feed of cash into these funds could be a good long-term bet.
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