Retirees and others seeking reliable, sustainable income may want to take close notice of the table below (Charlie Aitken remarked on it last Thursday [1]). These are forecasts from the Reserve Bank, published in their May Statement on Monetary Policy.
Critically, the RBA now expects underlying inflation over the medium term (at least out to the end of 2018) to be in the range of 1.5% to 2.5%.
This is 0.5% below their official target band. While they are not linking this explicitly to lower interest rates, the implications for investors are very clear. In a low growth, low inflation economy, interest rates are set to stay low for some considerable time.
[2]Click here to download a larger image [3]
So, if you are searching for yield, lower your sights — franked dividend yields of 5% are going to look pretty good, as will unfranked property or infrastructure yields beginning with a 6. Term deposits with a big figure of 2 might soon start to look good!
One option to get higher yield is to take on some more risk. A longer maturity date on fixed interest securities, investing in less credit worthy notes or debentures, or increasing the proportion of growth assets in your portfolio are potentially ways to increase yield. Another alternative is to invest in a specialist fund where the manager enhances the return.
There are a number of funds that do this. One class of product is Equity Income Funds, and one of the better products in this field is Investor Mutual’s Equity Income Fund. Let’s do a road test.
Investors Mutual Equity Income Fund
Designed for retirees and others seeking a higher reliable income, the Fund provides exposure to a diversified portfolio of high yielding Australian shares. It seeks to provide a distribution yield that is more than 2% above the market, while delivering an overall return that is less volatile than the market. This means that investors should expect a distribution return pre-franking of at least 7%, with less absolute risk.
[4]To do this, the Fund invests in a portfolio of quality high yielding ASX listed Australian and New Zealand shares, hybrids, bought and sold options and cash. Investors Mutual uses an active “bottom up” approach to identifying, researching and valuing companies, and seeks investments that offer one or more of the following characteristics:
- provide an absolute real return over the long term;
- pay a regular income stream;
- are less volatile (risky) than the market in which they trade.
The Fund uses option strategies to generate additional income and help manage risk. It illustrates this approach to using options within its portfolio:
[5]The Fund doesn’t use derivatives to speculate, nor to gear the fund.
Performance
The Fund benchmarks its performance against the S&P/ASX 300 accumulation index. Over the medium term, the performance has been very credible.
Performance to 30 April 2016
[6]* 1 January 2011
Investors Mutual says that it has also delivered on its other objective of lower risk, as measured by the annualized standard deviation of the returns. The Fund is running around 8%, while the market (S&P/ASX 300) is around 12.5%.
[7]The Manager
Investors Mutual has around $5.9bn in funds under management. Established by Anton Tagliaferro in 1998, it specialises in managing Australian equities.
The Equity Income Fund is managed by Jason Teh, and is approximately $285m.
Investors Mutual charges a management fee of 0.993% pa. There are no performance fees.
Our View
Investors Mutual isn’t the only provider of this style of equity income fund that uses options to enhance returns. Other managers include Armytage, Colonial First State and Zurich (via Denning Pryce).
One downside with some of these funds is that in recent times, the high distribution return has been earned partly at the expense of a negative capital return, as shown by a fall in the unit price.
Fortunately, Investors Mutual is not in this category and on track record, is probably the pick of the managers.
Distributions paid quarterly (expected to be around 7% to 9% pa) will be very attractive to many investors, although the franking percentage (37.3% in 2015) is relatively low. The minimum investment is $50,000.
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.