The great growth engines of tomorrow are not well represented on the ASX. This market has limited choice in information-technology, life science and clean-tech stocks. Few Australian consumer-staples stocks are leveraged to the middle-class Asian consumption boom, and investors have to go offshore to buy semi-conductor or advanced-materials stocks.
It’s a different story on yield. The high weighting of bank stocks in the S&P/ASX 200 index, and the benefits of franking credits, have made this market a yield paradise compared with most offshore. Income-seekers have little need to buy global stocks for yield.
Taking this theory a step further, investors could take a more passive approach to Australian shares, aiming for slightly better returns than the market and enhanced yield, and an active approach to offshore investing by investing directly in international shares and locally run international equities managed funds.
This approach has limitations and there is plenty of growth left in pockets of this market. But building the portfolio’s “core” around lower-risk Australian income investments, and using higher-risk offshore investments as portfolio “satellites” has merit.
One benefit is investors focus on choosing listed or unlisted funds for Australian income, rather than picking stocks. Granted, several of the big bank, infrastructure, listed property and utility stocks have been cracking investments in the past five years. But the “yield trade” looks increasingly crowded and expensive at current prices.
Reducing yield risk through a fund approach makes sense. The trick is choosing funds that enhance diversification without sacrificing yield. Several options exist in the listed-investment company, absolute-return (hedge) fund and exchange-traded fund markets, and through the ASX’s new mFund settlement service for managed funds.
Here are five options to consider:
1. Australian Leaders Fund (ALF)
Listed on the ASX, this fund uses a long/short investment strategy to maximise yield and manage exposure to equity-market risk. Its mandate allows it to short sell stocks, capitalise on market volatility, and preserve investor capital.
The $398 million fund has consistently outperformed its benchmark All Ordinaries Accumulation Index since 2009 and yielded 6.7%, fully franked at February 2016. Its five-year annualised total return (including dividends) was almost 14% to February 2016.
The underlying fund is outperforming the market: a net portfolio return of 9.23% for the first half of FY16 compared with 0.45% for the All Ords Accumulation Index. The fund has a good record of paying dividends in all market conditions.
ALF is not cheap. It trades at a 10% premium to its latest pre-tax net tangible assets, meaning investors are paying more for its assets than they’re worth on the market. Also, the fund’s approach to short-sell stocks and invest in IPOs and small- and mid-cap stocks adds some risk for conservative income investors.
But its performance warrants a small premium and a 6.7% fully franked yield for a basket of stocks, consistent over several years, is worthwhile. Waiting to buy the well-run ALF on any narrowing of the gap between the share price and NTA makes sense.
Australian Leaders Fund
[1]Source: Yahoo!7 Finance
2. Plato Australian Shares Income Fund
Using a specialist income managed fund for blue-chip dividend exposure makes sense for conservative long-term investors. Choosing one that is tailored for zero-tax investors, such as some Self-Managed Superannuation Funds and charitable funds, is even better.
The Plato Australian Shares Income Fund is an interesting option for investors in the pension phase, who can enhance income through franking credits and special dividends. Focusing on one type of investor helps the fund maximise income and capital returns, compared to managed funds that have investors with different taxation needs.
Available through the ASX’s mFund settlement service, the Plato fund invests in mostly blue-chip Australian shares with higher fully franked income. The big four banks and Telstra are five of its top 10 holdings.
The fund has had an annualised total return (including franked dividends) of 12% since its inception in September 2011, or about 2% more than its benchmark S&P/ASX 200 Accumulation Index. The annual yield is 8.9% inception (including franking) – an attractive rate of income for SMSFs.
The fund has averaged an excess return of almost 2% over five years over its benchmark and looks a sound way to boost income by a few percentage points. Prospective investors in the fund should consider if it overlaps with stocks, such as the big four banks, that are held directly in their portfolio.
3. Cadence Capital
The listed investment company’s unusual investment style combines fundamental and technical (charting) research to time entry and exit points in stocks. The long/short fund invests in large and small stocks and its success relies on active stock picking. Self Managed Super Funds comprise about two thirds of its investor base.
The strategy is working. Cadence Capital had a five-year annualised total return of 15.2% to February 2016, ASX/Morningstar data shows. Its trailing yield of 6.7% in February 2016 was among the highest in the LIC sector and it aims for a fully franked yield of 6-8% each year. Over 10 years, the fund has outperformed its benchmark All Ordinaries Index by 10.7% annually, before fees. The outperformance over three years is about 5%.
The key question with Cadence is valuation. It traded at a 13.4% premium to its NTA at February 2016, placing it alongside WAM Capital and, to a lesser extent, Djerriwarrh Investments, as the market’s priciest LICs.
Investors have been prepared to pay more for Cadence than its assets are worth because of its long-term performance and consistent dividend history. It’s never a good idea paying a substantial premium for LICs, but Cadence is among the more interesting of them for SMSFs and other long-term investors who are prepared to back funds that have a trading style.
Cadence Capital
[2]Source: Yahoo!7 Finance
4. SPDR MSCI Australian Select High Dividend Yield Fund (SYI)
Exchange-traded products that maximise yield now trade on the ASX and have been one of the fast-growing ETP segments in recent years. Some ETPs use different index methodologies to maximise yield; others incorporate options strategies to boost income.
For example, the BetaShares Australian Top20 Equity Yield Maximiser Fund (YMAX) had a 12-month gross distribution yield of 11.9% at 31 December 2015. It’s an eye-catching yield and the strategy has merit in the long run, but the product has underperformed the S&P/ASX 20 by almost 3 percentage points annually over the past three years.
I prefer the more conservative yield-focused ETPs, such as State Street’s SYI ETP. It takes a rules-based approach to index construction to tweak the yield and its top-10 holdings include the big-four banks, Telstra, Wesfarmers and Woolworths.
The ETP’s trailing dividend yield was 8.83% at February 2016 – slightly higher than similar yield-focused ETPs. Like other ETPs with a focus on top-20 Australian stocks, the total return is down over 12 months (17.6% over 12 months in Feb 2016). That could be an entry point to buy on weakness.
SPDR MSCI Australian Select High Dividend Yield Fund
[3]Source: Yahoo!7 Finance
5. iShares Treasury ETF
Income investors seeking lower-risk yield can consider a growing range of fixed-income ETFs on the ASX. Yields mostly range from 3-4%, not much better than cash returns, but there are exceptions.
The iShares Treasury ETF seeks to replicate the price and yield performance of the Bloomberg AusBond Treasury Index, and invests in mostly investment-grade fixed-income securities issued by the Federal Government.
The ETF had a 5.66% historic distribution yield at February 2016, ASX/Morningstar data shows – the highest yield in its product category. The three-year annualised total return was 4.7%.
It’s no world beater, but a 5% yield from a diversified portfolio of government bonds, and low management fees, will appeal to conservative investors. The yield is comparable to many blue-chip stocks (before franking) but with a lot less risk.
iShares Treasury ETF
[4]Source: Yahoo!7 Finance
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at March 23, 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.