Income investors face good and bad news. The good news is sharply higher term-deposit rates, thanks to 13 interest-rate rises since April 2022.
Some banks now offer introductory term-deposit rates above 5%. For retirees and other conservative income investors, higher yield from risk-free cash has been a godsend after years of measly returns.
The bad news is that 5% is not enough for many as living costs rise, unless one has millions in savings tucked away. Earning $50,000 of income on $1 million of retirement savings doesn’t go far in most cities these days.
The other bad news is dividend yields from Australian shares. The average yield from S&P/ASX 200 companies dipped below 4% (before franking) in May, Betashares analysis shows. The companies collectively paid out almost $1 billion less in dividends during the February 2024 reporting season due to rising interest and business costs.
What matters, of course, is the total return from shares (capital growth and income). But for investors who rely on dividends to live, it’s getting a little tougher, particularly so as high inflation erodes the real return on yield.
It will get worse on the dividend front as Australia’s economy slows this year and as companies earn less and return less of their profits as dividends. Not drastically so, but enough to make it harder for income investors in shares this year.
Investors who require a higher return from shares, and cannot survive on the cash return, can sell shares and use the proceeds to live on, or search for higher, reliable franked yield across the market.
This column focuses on the latter. My readers know I prefer using active or exchange-traded funds for income rather than investing directly in shares. Why get a 5% yield from a single share and take all that company risk, when you can get 5% (after fees) from a diversified fund holding dozens of stocks?
I favour the Listed Investment Company (LIC) market for equity yield for two reasons. First, the company structure of LICs means they can better manage future franked dividend flows from their retained earnings. The retained earnings of some LICs provide years of dividend cover and reliability for income investors.
Second, the LIC market has been battered in the past few years as more investors gravitate to ETFs and indexing, and retreat from active funds. Even the market’s largest LICs – Australian Foundation Investment Company (AFIC) and Argo Investments – are trading at unusually large discounts to Net Tangible Assets (NTA).
In theory, an LIC trading at a 10% discount to NTA means investors can buy $1 of assets for 90 cents. In effect, the investors are getting a higher yield on their investment because they are buying assets at a discount to their true value.
Premiums, discounts and yields are not clear-cut. Some LICs trade at a whopping discount to NTA because they have poor investment performance, a patchy dividend record or slack investor relations, and thus low share liquidity and too few investors buying the stock and driving its price higher.
Other LICs offer a jaw-dropping double-digit yield on paper. Closer inspection shows the yield is more likely a dividend trap and unlikely to be sustained. So, great care is needed in choosing LICs on discounts/premiums and yield alone.
With discounts, I like to compare the LIC’s current discount to its five-year historical average. LICs trading at an unusually large discount to their average discount tend to revert towards the average over time, and vice versa. It doesn’t always happen, but history is a reasonable guide to LIC discounts/premiums.
AFIC, for example, traded at a 9.9% discount to its NTA this week, on Bell Potter numbers. Over five years, AFIC has ranged from a discount of 7.5% to a premium of 19.6%, meaning it is historically beyond low end of its valuation range. On average, AFIC has traded at a 4.6% premium over five years, Bell Potter numbers show.
With yield, I look at grossed-up yield (after franking) and for LICs to yield around 6% or better. I then look at the LIC’s retained earnings to ensure it has good dividend cover and can maintain its expected dividend payment to shareholders.
Finally, I want LICs trading at an unusually large discount to their average NTA over five years and providing an attractive yield. Using those parameters, here are three LICs that look interesting for income-focused investors.
- WAM Leaders (ASX: WLE)
Several LICs from Wilson Asset Management, a top LIC manager, are unusually trading at a discount to NTA. That speaks to the challenges in the LIC market and the current opportunity to buy LICs from leading managers at big discounts.
WAM Leaders, an investor in large-cap Australian equities, is trading at a 0.6% discount to NTA, on Bell Potter’s latest numbers. WAM Leaders has traded an at average premium of 2.9% over the past five years.
At $1.33, WAM Leaders is yielding 9.8% after franking on Bell Potter numbers and had dividend coverage of 3.2 years at end-June 2024. That type of attractive franked yield – and the prospect of buying WAM Leaders at a slight discount to NTA – should appeal to income investors.
Chart 1: WAM Leaders
Source; Google Finance
- Djerriwarrh Investments (ASX: DJW)
From the same stable as AFIC, DJW is one of the largest income-focused LICs on ASX. It aims to deliver a higher income return than the ASX 200 provides, through stock selection and using options strategies to enhance yield.
In early July, DJW traded at a 10.1% discount to NTA. That’s near the bottom of its historical discount/premium range over the past five years. On average during that period, DJW has traded at a 4.2% discount to NTA. Like many other LICs, DJW is trading at an unusually large discount to NTA, using Bell Potter numbers.
DJW is yielding about 7% after franking. Long-term shareholders who have watched DJW’s share price drift lower over the past decade won’t be pleased. But for prospective income investors, DJW looks interesting after price falls.
Chart 2: Djerriwarrh Investments
Source: Google Finance
- Argo Investments (ASX: ARG)
I can’t recall when Argo, the market’s second-largest LIC, traded at an 11.4% discount to its NTA.
Argo’s current discount is beyond the bottom of its discount/premium range over five years (-9.1% to 10.9%), on Bell Potter numbers.
Argo’s expected gross yield is 5.8%. For investors who want exposure to large-cap Australian shares and their franked dividends, Argo is a more conservative option. Buying it at a larger discount than it normally trades at adds an interesting twist to one of the market’s top LICs.
Chart 3: Argo Investments
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 10 July 2024.
