Income funds suffer as BP cancels dividend

Equity income was uppermost in many investors’ and advisers’ minds during June with newsflow during the month dominated by speculation – and, eventually, confirmation – that troubled oil giant BP would cancel its dividend.

BP has been under pressure since the middle of April. Following an explosion at an offshore rig in the Gulf of Mexico, in which 11 people died, oil has been leaking into the ocean, and the cost to the company – not only in monetary terms, but also reputationally – continues to rise.

BP has cancelled its dividend payment for the next three quarters and announced it intends to sell oil and gas fields and reduce investment in drilling. The company has agreed to set up a $20bn (£13bn) fund to fund compensation claims filed by those affected by the oil spill, although BP’s actual liabilities are, as yet, unknown. President Obama warned that the fund would not cap BP’s liability for the costs of the cleanup, or supersede individuals’ or states’ entitlements to launch their own legal action against the company.

Before the news of the dividend cancellation, BP led the FTSE 100 companies in dividend payments. According to Capita Registrars, the top five UK companies for dividend payments – headed by BP – paid 56% of the FTSE 100 index’s total yield during the first three months of 2010. Some equity income fund managers are now wondering how to maintain their own funds’ dividend payments.

Many funds that hold BP are index-tracking portfolios that have no option but to own the stock. Even individuals without direct exposure to BP might be indirectly exposed through their pension fund or through a collective investment scheme. For its part, the National Association of Pension Funds estimates UK pension funds’ exposure to BP is only about 1.5% of their total assets, but remained cautious on the longer-term prospects for the company.

Although BP’s decision to cancel its dividend has created something of a headache for equity income fund managers, investors should not forget that the UK equity market includes many other sizeable companies with strong balance sheets that should help to plug the gap.

Looking further ahead, although BP’s future remains cloudy, and the costs of the oil leak continue to mount, it is worth remembering that many companies that cut or cancelled dividend payments during the torrid times of the credit crisis – most notably the major banks – have now resumed their payouts.