Casting your income net into international waters

The ongoing shift in asset allocation by Australian investors is seeing more money pushed offshore, with international shares making up an increasingly larger percentage of equity portfolios.

The strong performance of the US share market, which has gained 18 per cent so far this year, has been a magnet for many investors, with technology stocks such as Apple, Amazon and Alphabet (Google) remaining attractions for growth seekers.

Yet, when it comes to dividend income returns, it’s evident Australian investors are still heavily focused on stocks on the Australian Securities Exchange.

That makes sense in the context of Australia’s dividend imputation system, whereby some or all of the tax paid by a company may be imputed to shareholders as a tax credit to reduce the income tax payable on a distribution.

It remains a highly attractive concession for investors, although looming changes to the treatment of excess dividend franking cash refunds flagged by the ALP stand to water down the income streams of a large number of Australian retirees.

Which is why there could be an even greater shift of domestic retail investment capital out of Australia in the near term as investors hunt for yield alternatives further afield.

It’s a scenario not lost on ETF Securities Head of Australia and New Zealand Kris Walesby, who said income investors should be seeking out diversification in their yield sources anyway.

“Australians generally focus on yield in their own country, and that really makes sense,” Walesby said.

“From a developed world perspective, the Australian economy has had historically some of the highest savings rates and dividend rates, and they’re connected because companies need to give higher dividends than what’s available in a bank account, otherwise people will just save their money rather than investing.

“Now, with all the discussions on the franking credits, I think Australians are starting to get nervous, especially those close to retirement and definitely those who are already in retirement, because the structure of franking may change.

“The investors we’ve been talking to are becoming more and more aware that actually just seeking yield in your own country is not applying the diversification principles that you probably should apply to provide stability to your portfolio.”

The tech-dominated US market has not been looked at by many Australian income investors, primarily because most of the big technology stocks are not paying any dividends and instead are reinvesting back into their operations.

But Walesby noted there are many US stocks in the top 500 that actually are consistently paying good income yields above 6 per cent.

One of the problems for equity income investors in any country, however, is that income returns through dividends can easily be eroded through share market volatility.

ETF Securities has developed a workaround for this through its ETFS S&P 500 High Yield Low Volatility exchange-traded fund, which is listed on the ASX under the code ZYUS.

The fund manager analyses the top 75 highest yielding stocks in the S&P 500 index based on dividends paid over the previous 12 months. It then reweights its holdings based on past volatility and removes the 25 most volatile stocks, so it’s left with the 50 highest yielding, lowest volatility companies.

“So, it’s a pretty simple set of rules,” said Walesby. “You are culling many of the companies that don’t particularly pay out good dividends, and you are also culling those that may pay out but have quite aggressive price movements, which means that you could get a high payout but potentially a negative capital return.”

Over the last 12 months ZYUS has achieved a total return of 20.19 per cent, including a growth return of 13.45 per cent and an income return of 6.74 per cent. The total return compares with the MSCI USA index benchmark return of 14.19 per cent.

“You do now have the ability, as an Australian investor, to harness yield in other countries via products like this, and actually it’s not just ZYUS, there are other ones,” Walesby says. “There is also a fixed income range, that some of the providers have, that allow you to get access to yields offshore.

“Even if you are looking at Australian yield, you need to be looking offshore as well, because there are benefits, things like currency movements that can help you and make sure you have stability of your income.

“There’s things like capital growth rates as well. So when you’re looking at yield there is also obviously a capital growth component, and in countries like America the capital growth component is relatively more stable for the lower volatility funds than they are for the equivalents in Australia.

Walesby said what’s most important for Australian investors is to look for yield diversification, and that means looking offshore to ensure you’re taking advantage of the best opportunities globally.

“It’s really a diversification principle for yield, and all about not putting all your yield eggs into an Australian basket.”