In­vest­ing for in­come

With in­ter­est rates at record lows, tra­di­tional yield in­vest­ments no longer cut it if you want to pre­serve your wealth

Money Magazine Australia - - CON­TENTS - STORY SU­SAN HELY

In­vest­ing for in­come in this low-re­turn cli­mate is a big chal­lenge but it's not im­pos­si­ble. If you are fairly risk averse, though, you have a dilemma. Cash rates are 1.5%, term de­posits pay around 2.5% and long bond yields are 2.8%. With the Re­serve Bank ex­pect­ing in­fla­tion of around 2% over the next year, the re­turn from your cash af­ter tax isn’t keep­ing up with the cost of liv­ing. If you keep a large slab in term de­posits pay­ing 2.5%, the net re­turn is 1.3% if you are on the top mar­ginal tax rate. But this is be­low ex­pected in­fla­tion.

To avoid your money go­ing back­wards, you need to find in­come be­yond tra­di­tional in­come in­vest­ments. You also have to work harder at di­ver­si­fy­ing.

The good news is that if you are pre­pared to take on some risk and can live with volatil­ity, there are good yields still from Aus­tralian shares, Aus­tralian real es­tate in­vest­ment trusts (A-REITs), se­lect mort­gage trusts and high-yield­ing ex­change traded funds (ETFs).


One of the most re­li­able sources of in­come comes from the Aus­tralian share­mar­ket, says Don Ham­son, man­ag­ing di­rec­tor of Plato In­vest­ment Man­age­ment. “Although cash and fixed-in­come in­vest­ments are

tra­di­tion­ally con­sid­ered in­come in­vest­ments, there is a strong case for in­vest­ing in eq­ui­ties, par­tic­u­larly Aus­tralian stocks, for gen­er­at­ing in­come as well as cap­i­tal growth,” he says.

The Aus­tralian S&P/ASX 200 gen­er­ated an an­nual 4.5% cash div­i­dend in­come over the 10 years to March 31, 2017. Over the same pe­riod, you would have re­ceived less from cash with the of­fi­cial overnight rate av­er­ag­ing 3.8% while the one-year term de­posit rate also av­er­aged 4.5%.

Ham­son is a big fan of Aus­tralia’s unique frank­ing cred­its tied to Aus­tralian com­pa­nies’ div­i­dends. “For Aus­tralian res­i­dent in­vestors, frank­ing rep­re­sents a credit or re­fund of com­pany tax paid on Aus­tralian com­pany prof­its. Aus­tralian pen­sion-phase su­per­an­nu­a­tion in­vestors cur­rently re­ceive a full re­fund of frank­ing cred­its, so frank­ing cred­its rep­re­sent ex­tra in­come,” he says. Div­i­dends have boosted gains from the S&P/ASX 200 to pro­vide a re­turn of 6.1%pa over the 10 years to De­cem­ber 31, 2016, in­clud­ing 1.6%pa frank­ing for tax-ex­empt in­vestors such as pen­sion-phase su­per­an­nu­ants. This is based on the S&P/ASX 200 Frank­ing Credit Ad­justed An­nual To­tal Re­turn In­dex (Tax-Ex­empt).

Plato listed a fund de­signed to pro­vide monthly fully franked div­i­dends – In­come Max­imiser (ASX: PL8) – which raised $325.9 mil­lion.

Ham­son says what most in­vestors don’t un­der­stand is that the volatil­ity of div­i­dend in­come gen­er­ated by the share­mar­ket is around half as volatile as the value of the mar­ket. For ex­am­ple, with the in­dex level at 5700 you might ex­pect in two out of three years the change might stay within ei­ther 1000 points more or 1000 points less.

But the div­i­dend yield, in­clud­ing frank­ing, for the ASX 200 in­dex might be within ei­ther 0.5% more or less in a well-di­ver­si­fied port­fo­lio in two out of three years.

“The yield on the Aus­tralian S&P/ASX 200 In­dex has been re­mark­ably sta­ble for the past five years, av­er­ag­ing around 6% per an­num on a gross-of-frank­ing ba­sis,” says Ham­son.

How­ever, he adds, this is the yield on a di­ver­si­fied port­fo­lio of 200 stocks. “Sin­gle stock div­i­dends can be far more volatile. For ex­am­ple, BHP Bil­li­ton, once the bell­wether Aus­tralian stock, cut its div­i­dend by 80% in the 2015-16 fi­nan­cial year.”

But this year BHP in­creased its in­terim div­i­dend by 144%. “But the large cut last year high­lights the risk of re­ly­ing on a sin­gle stock for div­i­dends.

If an in­vestor only had BHP in their port­fo­lio, their in­come would have fallen by 80% in a sin­gle year,” says Ham­son.

He says the big four banks (ANZ, CBA, NAB and West­pac) rep­re­sent a large por­tion of the in­dex and have been great yield in­vest­ments over the past 20 years but all four cut their div­i­dends dur­ing the GFC.


In­come from Aus­tralian-listed real es­tate in­vest­ment trusts (A-REITs) is around 4.6%, but the his­tor­i­cal av­er­age for the sec­tor is around 6.4%. Con­sid­er­ing the low rates from cash and bonds, the yield is still fairly at­trac­tive.

The A-REIT sec­tor has had five con­sec­u­tive out­stand­ing years re­turn­ing 16.24%pa, more than three times 4.87% pa from the Aus­tralian bond mar­ket. Yields vary widely across the dif­fer­ent cat­e­gories and even within the same broad type of prop­erty.

An ad­van­tage of A-REITs is their di­ver­si­fi­ca­tion. In­stead of hold­ing all your money in one prop­erty, A-REITs di­ver­sify across a num­ber of dif­fer­ent re­gions and sec­tors such as re­tail, com­mer­cial and in­dus­trial as well as spe­cial­ist ar­eas such as health, child­care and aged care.

A-REITs are also liq­uid in­vest­ments that can be bought and sold eas­ily on the ASX or from a fund man­ager.


Un­listed mort­gage trusts can hold risks for in­vestors be­cause they are not sub­ject to on­go­ing mon­i­tor­ing by a mar­ket reg­u­la­tor. It can also be harder for in­vestors to know what is go­ing on their in­vest­ment.

Poor ex­pe­ri­ences with mort­gage trusts has meant that rat­ings houses do not rate many mort­gage trusts. One of the ex­cep­tions is La Trobe’s 12 Month Term Ac­count (for­merly the Pooled Mort­gages Fund) which has won eight con­sec­u­tive an­nual awards from Money mag­a­zine over the years for be­ing the best mort­gage fund. It is the only fund that three rat­ings groups, SQM, Lon­sec and Zenith, said was worthy of an award in the mort­gage fund cat­e­gory.

The min­i­mum in­vest­ment is $1000. The fund pays out monthly, suit­ing peo­ple on a fixed in­come.

The rat­ings agen­cies were im­pressed by La Trobe’s ex­pe­ri­ence, which stretches back to 1952 as a credit spe­cial­ist. The 12 Month Term Ac­count tar­gets a loan-to-val­u­a­tion ra­tio of a max­i­mum 75% and av­er­ages around 63%. “We avoid those as­set types that have tra­di­tion­ally pre­sented an en­hanced risk pro­file, such as land-bank­ing loans or loans se­cured by spe­cialised se­cu­rity prop­er­ties,” says Chris An­drews, chief in­vest­ment of­fi­cer.

From these as­sets, An­drews says La Trobe builds highly di­ver­si­fied per­form­ing loan port­fo­lios that have a long track record of gen­er­at­ing cap­i­tal-sta­ble, pre­mium-in­come re­turns for its in­vestors, both in­sti­tu­tional and re­tail. “Over 65 years we have never lost a cent of cap­i­tal for ei­ther our in­sti­tu­tional in­vestors or in­vestors in our re­tail pooled port­fo­lio ac­counts. Over that time we have worked through many dif­fer­ent eco­nomic cy­cles and this time is no dif­fer­ent.

“At present the banks face in­creased cap­i­tal re­quire­ments –they need to hold more cap­i­tal for each loan they write – and are be­ing used as an al­ter­na­tive pol­icy lever by the fed­eral gov­ern­ment and their reg­u­la­tor, APRA, which are search­ing for so­lu­tions to is­sues such as hous­ing af­ford­abil­ity. It is likely that these driv­ers will con­tinue to af­fect the banks at least into the medium term and re­duce the avail­abil­ity of credit for qual­ity bor­row­ers.”

ASIC has de­vel­oped eight bench­marks and dis­clo­sure prin­ci­ples for in­vestors who are con­sid­er­ing in­vest­ing in mort­gage trusts. They in­clude check­ing on the trust’s liq­uid­ity (par­tic­u­larly the with­draw­ing ar­range­ments), bor­row­ings, loan port­fo­lio and di­ver­si­fi­ca­tion. Most im­por­tantly find out if there are any re­lated party trans­ac­tions, ex­am­ine the val­u­a­tion pol­icy, lend­ing prin­ci­ples and loan-to-val­u­a­tion ra­tios. La Trobe has other in­come prod­ucts that pay higher rates but they carry a higher risk pro­file.

Newspapers in English

Newspapers from Australia

© PressReader. All rights reserved.