Fallen interest rates and dividend pressure
Despite a stream of disparaging dividend headlines, large, stable dividend payers have sustained and grown payouts while smaller, weaker firms in hard-hit industries have struggled. Aggregate dividends announced by S&P 500® firms to be paid in the year ahead remain nearly as large as the past year. Unlike during the global financial crisis, credit markets are open, and liquidity flows freely. Between unprecedented intervention from the Fed and fears of the economic fallout from a COVID-19 resurgence, bond yields remain stubbornly low, capping the reward for traditional, high-quality fixed income investments. Equity income exposures offer elevated cash flows and the prospect of long-term growth relative to traditional fixed income investments.
An accelerating global health crisis and November elections loom large in the mind of investors. Developments on both fronts contribute to daily volatility. We don’t know what the future holds, but we can control portfolio construction and systematic implementation to ensure investors stay on their target—one size need not fit all.
Mutual fund gain distributions
In an effort to reduce the burden of COVID-19 on taxpayers, the federal government extended the income tax filing deadline to July 15. The extension offered relief to many taxpayers, but it may prove to be a setback for investors paying capital gains taxes on mutual funds. Investors are generally at the mercy of fund managers when buying mutual funds, which can lead to investors inheriting a fund’s cost basis when paying capital gains. Larger shareholders with more influence can drive the buying and selling decisions of mutual funds, and redemptions can often trigger those capital gains.
This outcome has become more pronounced as of late, with capital gains distributions in the equity market rising over the past decade to hit $318 billion in 2019. Amid market volatility, we can expect to see an increase in liquidity outflows in the second half of the year. When combined with the high amounts of unrealized gains, these outflows could mean large capital gains distributions in 2020.
We suggest replacing or combining mutual fund holdings with tax-efficient custom SMAs that seek to offset gains and lower investors’ tax bills. In times of volatility, it becomes increasingly difficult to time and size distributions, but there are options for mitigating and eliminating exposure to distributions and their ensuing taxes.
Diversity and transparency through shareholder engagement
In light of recent events that continue to highlight racial inequality in America, increasing diversity is a priority in boardrooms across the nation. We’re starting to see more women being appointed to boards (however, we still have a long way to go before parity), but much more progress needs to be made for racial and ethnic minorities. This leads us to ask: Do we have the data we need to assess progress on diversity and inclusion at all levels of seniority in the corporate world?
We checked in with Gwen Le Berre, Parametric's director of responsible investing, and her research indicates that data on demographic characteristics like race isn’t as robust as it is for gender. Gwen suggests leveraging shareholder engagement to make the biggest impact on companies. Having conversations with key decision makers nudges companies to create better disclosures, which are necessary for measuring progress and keeping companies accountable. Gwen’s team is working to increase public disclosure of EEO-1 data, which is a new shareholder engagement initiative for New York’s comptroller. Increasing representation of minorities in boardrooms is about social justice, but it’s also about better corporate governance. It’s important for boards to reflect on their own composition, and having diversity of thought can lead to better-informed decisions.
The bottom line
The uncertainty of 2020 has taught us the importance of adaptability. Investors and advisors who embrace flexibility and transparency may be best positioned to navigate whatever comes our way in the second half of 2020.