Spread betting – FTSE pension trouble could hit dividends

UK stocks, particularly large caps, have rallied firmly since the EU referendum vote in June. A weak pound has undoubtedly helped lift some of the key members of the FTSE 100, but a crushing bond rally is also at work.

As gilts have soared this year, yields on government paper have collapsed, hitting record lows. With investors seeking anything with a decent return, they’ve switched attention to equities, particularly those that pay out a healthy dividend.

But could this crushing bond rally ultimately scupper the equity boom?

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Pension Deficit

 

The problem lies in the gaping hole in companies’ pensions schemes, which latest figures show is getting bigger.

According to Mercer, the accounting deficit of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies (FTSE 350) rose £50bn in just a month to a record high. The report shows the gap increased from £139bn at the end of July to £189bn by the end of August.

“Despite an increase in asset values over the month, August saw the biggest monthly rise in deficits since records began,” said Ali Tayyebi, senior partner in Mercer’s Retirement business. “This was largely driven by a further sharp fall in long dated corporate bond yields. This also means that our reference long-dated corporate bond yield has now fallen below 2% p/a for the first time representing yet another milestone into uncharted territory.”

Dividends in Danger?

 

Only last month LCP reported that FTSE 100 companies had paid five times more in dividends than into pension schemes. But it’s uncertain if this can be sustained – earnings growth will need to exceed expectations to cover the dividends at the current rate.

The gap in pension funding could hit dividends over the coming months (and by implication share prices) as companies may be forced to plough more into their pension schemes, diverting earnings away from shareholders. Following the debacle at BHS and report by the Treasury Select Committee, the Pensions Regulator could lean more heavily on those firms with the biggest gaps – BT, Tesco, BP and BAE Systems come to mind as having the biggest deficits, but there are others.

Last week Carclo warned that a burgeoning deficit would hit its dividend. More could follow as dividend cover is already very light.

In July, The Share Centre and Capita’s dividend monitor suggested trouble could be ahead. Cover for the FTSE 350 fell to its lowest level since the third quarter of 2009, dipping 38% to 0.98 from 1.63.

Boards will need to walk a fine line between placating shareholders and ensuring their pension schemes don’t get out of control.

Le Roy van Zyl, senior consultant in Mercer’s Financial Strategy Group, believes “these numbers will have to be dealt with”.

He adds: “There are few easy answers here, apart from the obvious one that any action, including ‘no action’, should be carefully considered amongst the key stakeholders. Letting things drift can be just as dangerous as taking knee-jerk actions.”