Chas­ing yields

Your hard­earned sav­ings will waste away in a term de­posit. Thank­fully, there are other di­ver­si­fied in­vest­ments that will pro­vide a de­cent in­come

Money Magazine Australia - - CONTENTS - STORY PAM WALKLEY

Record low in­ter­est rates are great if you’re pay­ing off a mort­gage or re­duc­ing debt but for those who need to live off in­vest­ment in­come, in­clud­ing re­tirees, it’s been very hard. Leave your money in a bank ac­count – where de­posits up to $250,000 are guar­an­teed by the fed­eral govern­ment – and your spend­ing power goes back­wards. But the al­ter­na­tive – shares and other bet­ter-pay­ing in­vest­ments – in­curs more risks.

Term de­posit rates have plum­meted over the past year, with the av­er­age rates for terms be­tween one month to five years fall­ing be­tween 0.47% and 1.05% in the year to June 2017, ac­cord­ing to re­search from Canstar (see ta­ble).

Hav­ing a spread of dif­fer­ent types of as­sets, in­clud­ing some cash, is the key. Di­ver­si­fy­ing your port­fo­lio will help to buf­fer the risks in­volved.

No­body wants to have to sell when share prices are fall­ing be­cause they need the cash

Re­tirees not want­ing to erode their cap­i­tal too quickly should con­sider hav­ing some of their funds in the share­mar­ket, par­tic­u­larly div­i­dend-rich Aus­tralian stocks. It’s im­por­tant to re­mem­ber that share in­vest­ing is not short term and you need to use money that you can lock away for at least three to five years. No­body wants to have to sell when share prices are fall­ing be­cause they need the cash.

The Aus­tralian mar­ket is unique in that there are many com­pa­nies that pay healthy div­i­dends and also en­joy frank­ing cred­its, mean­ing you can do much bet­ter than the measly re­turns from term de­posits.

But for many, choos­ing the right stocks is far from easy, so it’s worth­while con­sid­er­ing a man­aged fund, ex­change traded fund (ETF) or listed in­vest­ment com­pany or trust (LIC/LIT) set up to max­imise yields. Fund man­agers recog­nise this and have been busy de­vel­op­ing new in­vest­ment ve­hi­cles for yield-hun­gry in­vestors.

Risk-ad­justed re­turns

First off the block are two listed in­vest­ment trusts. These have a sim­pler struc­ture than LICs and are sim­i­lar to a prop­erty trust, ex­cept they in­vest in other types of as­sets rather than of­fice blocks or shop­ping cen­tres. LITs are a model that’s en­trenched in the UK mar­ket but has not taken off in Aus­tralia, where about $33 bil­lion has been raised by LICs.

The MCP Mas­ter In­come Trust (ASX: MXT) aims to pro­vide in­vestors with in­come from Aus­tralian cor­po­rate loans. Its tar­get re­turn rate is the Re­serve Bank cash rate plus 3.25% net of fees (4.75% cur­rently). Dis­tri­bu­tions are paid monthly.

It’s the first ASX-listed in­vest­ment trust to cover cor­po­rate lend­ing, pro­vid­ing in­vestors with ex­po­sure to a port­fo­lio that re­flects ac­tiv­ity in the Aus­tralian cor­po­rate loan mar­ket, di­ver­si­fied by bor­rower, in­dus­try and credit qual­ity. The trust ini­tially will have ex­po­sure to over 50 in­di­vid­ual in­vest­ments with a near-term tar­get of 75 to 100 in­di­vid­ual in­vest­ments.

An­drew Lock­hart, MCP’s man­ag­ing part­ner, says the trust presents a unique op­por­tu­nity for in­vestors to ac­cess an ASX-listed fixed-in­come in­vest­ment. “The trust of­fers in­vestors ex­clu­sive ac­cess to the highly at­trac­tive risk-ad­justed re­turns avail­able in the cor­po­rate loan mar­ket, his­tor­i­cally only avail­able to reg­u­lated lo­cal and in­ter­na­tional banks.

“Fixed in­come is a vi­tal com­po­nent of a bal­anced in­vest­ment port­fo­lio. Fixed-in­come in­vest­ments of­fer pre­dictable cash in­come with low risk of cap­i­tal loss. We an­tic­i­pate the trust will res­onate strongly with re­tail and self-man­aged su­per fund in­vestors, who have tra­di­tion­ally had low al­lo­ca­tions to this as­set class.”

Be­tween 2000 and 2016, Aus­tralian cor­po­rate bonds gen­er­ated a me­dian re­turn of 6.7% a year, with a high of 11% in one year and a low of 3%, with only cash of­fer­ing lower volatil­ity of re­turns.

Another new listed in­vest­ment, the Mag­el­lan Global Trust (MGG), aims to pro­vide in­vestors a tar­get cash dis­tri­bu­tion of 4% a year from a port­fo­lio of 15 to 35 of the world’s best com­pa­nies.

“We be­lieve it is im­por­tant that Aus­tralian in­vestors di­ver­sify a mean­ing­ful por­tion of their eq­uity in­vest­ments into global eq­ui­ties,” says Hamish Dou­glass, co-founder, CEO and CIO of the Mag­el­lan Fund Group and port­fo­lio man­ager of the new LIT. “The avail­able in­vest­ment uni­verse in Aus­tralian eq­ui­ties is rel­a­tively nar­row and, in our opin­ion, re­mains heav­ily de­pen­dent on the on­go­ing eco­nomic suc­cess of China, the do­mes­tic econ­omy and the large Aus­tralian banks. Com­pa­nies such as Al­pha­bet [the owner of Google], Ap­ple, Mi­crosoft, Nestlé, Pay­Pal and Yum! Brands are world lead­ers in their fields that have no equiv­a­lents on the ASX. Aus­tralians are fa­mil­iar with these names be­cause we use their prod­ucts and ser­vices all the time.”

The trust aims to in­vest at a dis­count to its as­sess­ment of each com­pany’s un­der­ly­ing in­trin­sic value. “We be­lieve in­vest­ing in such a port­fo­lio should gen­er­ate at­trac­tive in­vest­ment re­turns over time while re­duc­ing the risk of a per­ma­nent cap­i­tal loss,” says Dou­glass.

Dis­tri­bu­tions will be paid twice a year and MGG has spec­i­fied its ini­tial pay­ments to pro­vide unithold­ers with cer­tainty. It will pay 3¢ per $1.50 unit each half year (start­ing in De­cem­ber 2017) in the first two years and after that set a 4% an­nu­alised yield based on a rolling 24-month net as­set value and an­nounced six months in ad­vance.

“Smooth­ing” strat­egy

A fea­ture of the Mag­el­lan trust that might not win favour with in­vestors is a de­ci­sion to cap “cash” dis­tri­bu­tions and force unithold­ers to rein­vest “ex­cess” dis­tri­bu­tions, says in­vest­ment an­a­lyst John Ka­vanagh, from The Rub, an on­line pub­li­ca­tion aimed at re­tail in­vestors.

Un­der nor­mal cir­cum­stances, trusts pay out all in­come and re­alised cap­i­tal gains to unit hold­ers, says Ka­vanagh. But in years when the net in­come or net cap­i­tal gains earned by the Mag­el­lan trust ex­ceed the dis­tri­bu­tion tar­get, the ex­cess will be re­quired to be rein­vested as ad­di­tional units through the dis­tri­bu­tion rein­vest­ment plan (DRP).

In­vestors usu­ally like to make their own call about whether they rein­vest their re­turns and some might see this condition as a deal-breaker, says Ka­vanagh. “Another pos­si­ble con­cern for in­vestors is that when ‘ex­cess’ dis­tri­bu­tions are rein­vested they will not qual­ify for the DRP dis­count of 5% that Mag­el­lan is of­fer­ing.”

A spokesman for Mag­el­lan told The Rub that the aim of the dis­tri­bu­tion strat­egy is twofold: to give in­vestors a con­sis­tent and pre­dictable yield through a “smooth­ing” mech­a­nism and to use the DRP to sup­port the unit price and thus avoid the prob­lem of hav­ing the trust

trade at a dis­count to its net as­set value.

One as­pect of the Mag­el­lan float that was ap­plauded by in­vest­ment an­a­lysts was its de­ci­sion to cover the cost of list­ing, typ­i­cally about 2.5% for a LIC, to en­able the trust to trade with­out a dis­count on de­but. With MGG due to list on the ASX on Oc­to­ber 18 we will soon know if this strat­egy worked.

Another new LIC, VGI Global In­vest­ments (VGI), also ab­sorbed all es­tab­lish­ment costs so that the se­cu­ri­ties would trade in line with their net as­set value upon list­ing rather than a dis­count, as is usu­ally the case.

VGI Part­ners, a high-con­vic­tion global eq­uity man­ager based in Sydney and New York, is look­ing to repli­cate the method­olo­gies em­ployed by its un­listed VGI Part­ners Mas­ter Fund via the new LIC. It will in­vest both long and short in global eq­ui­ties. The port­fo­lio man­agers will also em­ploy a cur­rency hedg­ing strat­egy while aim­ing to de­liver strong risk-ad­justed re­turns.

Un­like the pre­vi­ous prod­ucts out­lined in this ar­ti­cle this LIC is not aimed at pro­vid­ing reg­u­lar in­come. “De­liv­er­ing a high div­i­dend is not a pri­mary ob­jec­tive of the in­vest­ment strat­egy or the man­ager,” says the prospec­tus. “The in­vest­ment strat­egy’s pri­mary ob­jec­tives are fo­cused on cap­i­tal preser­va­tion and gen­er­at­ing su­pe­rior risk-ad­justed re­turns over the long term. As a re­sult, there may be ex­tended pe­ri­ods where the com­pany does not pay reg­u­lar franked div­i­dends to share­hold­ers.”

Tra­di­tion­ally VGI man­aged cap­i­tal for high-net-worth in­vestors with the min­i­mum ap­pli­ca­tion amount for their un­listed fund sit­ting at $1 mil­lion. The new LIC of­fers re­tail clients rare ac­cess to an in­vest­ment ve­hi­cle man­aged by a team with a long track record.

The method­ol­ogy has been suc­cess­ful, re­turn­ing an an­nu­alised 14.6%, since it was es­tab­lished about 8½ years ago, out­per­form­ing the MSCI World In­dex (AUD), which re­turned 10.7%pa over the same pe­riod.

Another in­vest­ment in the pipe­line aimed at pro­vid­ing in­come as well as growth is Roger Mont­gomery’s first ex­change traded man­aged fund (ETMF) to be quoted on the ASX. “The fund will mir­ror our very suc­cess­ful Mont­gomery Global Fund, of­fer­ing ac­cess to ex­tra­or­di­nary global com­pa­nies not avail­able through much larger global funds,” says Mont­gomery. The fund will also tar­get a min­i­mum an­nual dis­tri­bu­tion yield of 4.5%.

The Mont­gomery Global Fund, which was es­tab­lished in July 2015, re­turned 6.99%pa in the two years to July 2017, out­per­form­ing its bench­mark, the MSCI To­tal Re­turn In­dex, by 3.88%pa. Lon­ger­estab­lished prod­ucts for in­vestors seek­ing in­come in­clude the Van­guard Aus­tralian Shares High Yield ETF (VHY) that had a to­tal re­turn of 11.42% for the year to July 31 and an av­er­age fiveyear re­turn of 10.54%pa. Rus­sell In­vest­ments’ High Div­i­dend Aus­tralian Shares ETF re­turned 9.82% in the year to July (5.35% dis­tri­bu­tion re­turn) and 11.06%pa over five years (5.69% dis­tri­bu­tion re­turn). And two big div­i­dend-seek­ing LICs, Clime Cap­i­tal (CAM) and Wam Cap­i­tal (WAM), are yield­ing 5.6% and 6.1% re­spec­tively. Be­cause ETFs, LICs and LITs are listed on the ASX they are very liq­uid and you need only $500 to start in­vest­ing in them.

Un­listed uni­verse

There’s a lot more choice with man­aged funds but for some in­vestors it’s too much, and the com­pli­ca­tions of buy­ing and sell­ing can also be a turn-off. Some man­agers have ASX-listed ver­sions of their funds, called mFunds, but there are far fewer of these.

As an ex­am­ple, the Legg Ma­son Mar­tin Cur­rie Eq­uity In­come Trust has been a good long-term per­former, re­turn­ing 5.61% net over the year to July 31, 8.73%pa over three years and 13.25%pa over five years. The min­i­mum in­vest­ment is $30,000.

Mort­gage funds are another in­vest­ment gen­er­at­ing higher re­turns than term de­posits but these have had a che­quered his­tory so it’s im­por­tant to choose care­fully. La­Trobe’s 12-month term ac­count (for­merly the Pooled Mort­gages Fund) has won Money mag­a­zine’s Best Mort­gage Fund award eight years in a row.

La­Trobe was one of a hand­ful of mort­gage fund man­agers that made it through the GFC and it’s been in busi­ness for over 60 years. You can ac­cess this fund with a min­i­mum of $1000 and all money is in­vested in cash or loans se­cured by first mort­gages in Aus­tralia. It’s pay­ing 5.2%pa and dis­tri­bu­tions are monthly.

Yield-hun­gry in­vestors are em­brac­ing P2P (peer-to-peer) lend­ing, even though it’s rel­a­tively new in Aus­tralia. RateSet­ter, lo­cally owned but part of the RateSet­ter group founded in the UK in 2009, en­ables you to start with as lit­tle as $10 with lend­ing terms of be­tween a month and five years. In­ter­est rates you re­ceive vary but at the time of writ­ing they were 3.8% for one month, 5.2% for one year, 7.8% for three years and 9% for five years.

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