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Dividends in demand when rates are low

The following article appeared in the Australian Financial Review on 16 July, 2018
By · 16 Jul 2018
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16 Jul 2018
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Income Investors favour businesses with a good dividend policy

By Alexandra Cain

 

Equity markets have been hot in recent years, but there is still plenty of opportunities to identify decent yield-generating investments, say the experts.

According to the Janus Henderson Global Dividend Index, listed companies paid out more than $USL25 trillion in dividends in 2017, about 8 per cent up compared to the previous year.

Jane Shoemake, investment director global equity income with Janus Henderson, says companies are able to attract investors when they have a good dividend policy.

"This is well established in Europe, the UK and Australia, and a dividend-paying culture is now providing opportunities across Asia Pacific, with notable dividend growth from Japan and selected emerging markets," she says.

Shoemake says investing globally gives investors exposure to a broad range of income opportunities. However she warns against chasing yield without considering the underlying strength of the company and its ability to generage cash to pay dividend. She notes high-yielding equities can be more risky than their lower-yielding counterparts, especially when share market gains push yields down.

"The high-yielding companies that are left can be structurally challenged businesses or companies distributing a high percentage of their earnings as dividends that may not be sustainable. An investor simply focusing on yield, and not on a company's ability to generage free cash flow to pay and grow its dividend, may end up owning a disproportionate percenatage of these companies."

She recommends investing across a diversified list of moderate-yielding companies, with attractive cash flow characteristics and the potential to offer both dividend and capital growth over the medium-to long-term.

Turning to the local bourse, Andrew McAuley, chief investment officer, private banking Australia for Credit Suisse, notes that over the last year a yield-oriented Australian equities portfolio has produced a lacklustre return. 

"While the ASX 200 has risen 13 per cent for the year ended June, high-yield sectors such as telecommunications, utilities and financials have underperformed. Telecoms and banks in particular have suffered from strong competition and more restrictive regulation. This has led the market to question the sustainability of dividends," he says.

McAuley believes the best way for investors to achieve their return goals is through investing in a portfolio that includes a range of investments that produce yield.

"By combining bonds, equities and alternative Investments such as infrastructure or hedge funds, returns are smoothed, and the Investor can realise profits over time to augment yield." He says while bonds may not look attractive in a rising-yield world - corporate bonds with a strong credit rating are currently producing only around 3 per cent in yield to maturity bonds ' objectives are Income and capital ability.

"Also, not all fixed-income Investments are alike. Floating rate notes, higher yield debt and syndicated loans can produce good returns in a rising yield environment, and can be accessed through funds."

According to McAuley, adding bonds to a portfolio does not necessarily mean the sacrifice of return. "Looking at data from 1998 on, a simple portfolio with 50 per cent in both long duration bonds and Australian equities, that is rebalanced annually, would have achieved a return slightly above the ASX 200, but with much lower volatility."

He notes poor returns from yield sectors have seen Australian investors crowd into stocks with growing earnings such as those in the healthcare and small local technology sector.

"The price to earnings multiple of the ASX 200 Industrials ex Financials sector is almost at an all-time high relative to the valuation of the broader market. Growth stocks are rare and expensive in Australia. We argue, despite the attraction of franking credits and a generally higher yield, a portfolio should include international equities where the opportunity set is much deeper, and risks can be spread further."

How to achieve a good yield without increasing risk in a low-interest-rate environment has been a conundrum for investors in recent years.

"This is the magic question and in investing there's no such thing as a free lunch. What's extremely important is that within this process investors identify and understand what any new or additional risk factors are," says Stuart Fechner, director, retail research relationships at Bennelong Funds Management.

"Typically, to generate an increased yield some level of additional or at least different risk is involved," he says.

James Carlisle, head of research at InvestSMART, observes investors do not have to add risk to generate yield, they just have to give up growth.

"If you go beyond the return expected from an assest class, say 7 per cent to 8 per cent for shares, then you'll be exposed to negative growth. So, if you're buying a stock with a yield of 10 per cent, the share price or the dividend is likely to fall. It still might make a decent investment - it just depends how much it falls," he says.

Fixed-interest investments have an important role to play. But exactly what that role is depends on the investor's view of the direction of rates and, when it comes to dividends, company profits. 

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