A colleague this week asked me to nominate my top investment issues for 2025. Trump? Tariffs wars? Overseas wars? Rate cuts? Artificial intelligence?
I couldn’t separate two issues. The first was the rallying Greenback as more capital returns to the United States next year. I focused on that trend here in last week’s Report, which was timely given news of Trump’s tariff policy this week and weakness in the Australian dollar versus the Greenback.
The other issue is income investing. Yes, income investing is seemingly not as exciting as the issues above. But for the many Australian retail share investors who buy stocks for their dividend yield, income investing is vital.
Income investing could be harder next year. In 2024, juicy rates on term deposits were a bonus for income-focused investors, particularly retirees who suffered from low returns after COVID-19 when interest rates were near zero.
As rates are cut in 2025, returns from cash accounts will fall. To be clear, I expect rate cuts to be delayed in Australia next year due to persistent higher inflation – a position I have outlined several times in my column in this Report this year.
The market seems to be forming a similar view, with Westpac and the National Australia Bank adjusting their rate-cut expectations to May. I wouldn’t be surprised if rate cuts are delayed beyond May, given employment strength and reckless Federal and State government spending that is fuelling inflation.
Still, income investors in cash accounts should expect lower yield on cash investments in the second half of 2025 as rates eventually fall.
Typically, when cash rates fall, income investors focus more on the equity market for dividend yield. But total dividend payments from S&P/ASX 200 companies in FY24 had slightly negative growth, in a tough year for income investors.
I can’t see dividend growth doing much better in 2025 if resource companies’ earnings are under pressure from slowing Chinese demand, and as bank dividend growth slows slightly as rates fall and credit demand is subdued.
As our economy limps along in 2025, it’s hard to see companies, on average, increasing dividends. More likely is flat or slightly negative dividend growth.
Moreover, with the Australian share market at a record high, the average dividend yield for new investors is less attractive. An indicative yield of 3.7% on the ASX 200 Index at end-October 2023 hardly inspires.
All this points to a tougher year for income investors in 2025 and the need to work harder for every basis point of return. If inflation remains elevated for longer, the purchasing power of income investors will continue to be under pressure.
With income investing, the key is focusing on a company’s total return rather than income alone. It’s pointless buying a stock for its yield if its share price falls.
Also, the best source of income is often through capital gains. That is, selling part of an investment to free up capital to be used as income. For example, taking a few profits on Commonwealth Bank of Australia shares to use for income.
Caveats aside, I like using covered call options to enhance income in 2025. Covered calls are an options strategy to generate additional income in the form of options premiums. The strategy tends to work best for investors who believe the underlying price will not move too much over the near term – a reasonable view with the ASX 200 at a record high.
I particularly like using covered call over indices and taking a fund approach, which is possible now through ETFs that implement covered call options.
Like all investment strategies, covered calls have risks. Significant price appreciation could cap gains and high-volatility stocks could cause losses.
If, like me, you expect more subdued returns from equities in 2025 in more of a rangebound market, after strong gains this year, a covered call options strategy is a consideration to enhance income returns.
Here are two covered call ETFs:
- Global X S&P 500 Covered Call ETF (ASX: UYLD)
As readers know, I like the outlook for US equities in 2025 even after this year’s rally. Gains will be slower from here, but Trump’s plans to cut the US corporate tax rates, reduce bureaucracy and speed up project approval times could be a tailwind for US equities if enacted (with plenty of volatility along the way).
The Global X S&P 500 Covered Call ETF uses a covered-call or ‘buy-write’ strategy, where the fund buys stocks in the S&P 500 Index in the US and writes (sells) corresponding call options in the index to generate income.
UYLD’s appeal is having a covered call strategy over 500 stocks through one fund, saving the time and hassle of implementing this strategy for individual stocks.
UYLD returned 12.6% over one year to end-October 2024, below its benchmark index (14.6%) and well below the S&P 500 Index (33.4%). Investors were better off investing in the S&P 500 without a covered call strategy, due to the index’s strong price uptrend, which capped gains on the strategy.
Chart 1: Global X S&P 500 Covered Call ETF
Source: Google Finance
That could change in 2025 as the US equities rally slows, creating a more conducive backdrop for UYLD. The ETF’s 12-month yield was almost 8% at end-October 2024, Global X data shows.
- Global X S&P ASX 200 Covered Call ETF (ASX: AYLD)
This is the same covered call options strategy, this time over Australian equities through the S&P/ASX 200 Index. AYLD returned 18.4% in the year to end-October 2024, Global X data shows. That compared to 26.3% for the ASX 200.
As with US equities, investors over one year were better off investing in the ETF that tracks the ASX 200 Index without the covered call strategy. AYLD had a 12-month yield of 7.62% at end-October 2024.
It’s easy to be deterred by the underperformance of AYLD and UYLD compared to their respective indices (without the covered call strategies). Both ETFs suffered from rallying equity markets that limited gains.
If you expect equity markets to neutral to slightly bullish in 2025, after the strong rally in fourth-quarter 2024, covered call options strategies using ETFs are a consideration for experienced investors who can take a more active approach to income investing, tailoring their strategy to expected market conditions.
Both ETFs are unhedged for currency movements and charge 0.6% annually.
Chart 2 Global X S&P 200 Covered Call ETF
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 27 November 2024.
