There's money in non-banks too

Bank stocks have underpinned the market’s desire for yield in 2012. In 2013 the spotlight may also move to non-bank financials.

PORTFOLIO POINT: Investors hunting for yield may also want to consider non-bank financial institutions, with some returning over 7%.

Just now, cash rates across the world are sitting at remarkable low levels: The Bank of England’s 10-year benchmark rate is the lowest in its 318-year history, while US Treasury yields are at record lows based on data going back to 1790, and 10-year Dutch yields have reached a 495-year low.

Petrified about deflation, central banks are buying long-dated Treasuries to support their economies – keeping interest rates as low as possible.

In Australia we are having our own little fixed-interest boom. Official cash rates have been cut back to the “emergency” level of 2009, when the RBA was trying to stimulate the economy in the aftermath of the global financial crisis.

Despite plummeting rates, fixed-interest brokers are still reportedly signing up record numbers of new clients every day, more interested in putting cash under the mattress than investing in productive assets.

The perception for some is that having money in the bank is still far safer than a volatile market. These people may have forgotten the mid 1970s in Australia, when inflation sat above 12% per annum for several years running. For those that had the bulk of their savings in passbook savings accounts earning 3.3% on minimum balances, there was to be a massive transfer of wealth.

The danger is that too many Australians are about to repeat the same mistake again when asset price inflation inevitably begins to bite as a result of the low cost of money around the globe.

While inflation remains currently in check, it is sure to re-emerge as a threat to the Australian economy. At times like these, investors need to be fully-invested in productive assets that have the capacity to maintain margins in real dollars.

Having jumped out of the stockmarket at the bottom post GFC, too many investors have already missed the first signs of recovery.

For the year to date, the S&P/ASX 200 Index has increased 10.9% and the S&P/ASX 200 Accumulation Index has increased by 16.2% – this means the average dividend yield for the index over the year to date has been 5.3%.

If this is assumed to be fully franked, the yield converts to 7.6% before tax. If capital gains are added back, the total pre-tax return is 18.5%.

The benchmark is trading at an average multiple of 13.6 times FY2013 forecast earnings, with a prospective dividend yield of 4.9% (according to aggregated estimates from Capital IQ).

Compare this to the 10-year Australian government bond rate of 3.1%, which implies a P/E of greater than 30 times. You can have bubbles in debt markets too remember!

One issue for the Australian stockmarket is that we are already overweight resource stocks and financials, which collectively make up more than 50% of our market compared with 27% of the S&P Global 1200. Arguably, both are heavily dependent on the prospects for growth out of China.

Those looking for yield could therefore choose to look across the industrial sector – and beyond the big banks. Figure 3 presents a list of the top-yielding industrials in the S&P/ASX 200, based on consensus estimates. While this analyst has no special insight into the prospects of many of the companies listed, I suspect that many of the forecast yields will prove illusory because of industry or company-specific issues and as the Australian economy continues to slow.

One sector that offers such protection is the financial services sector. The list in Figure 4 of members of the S&P/ASX Financial Services index excludes those that derive the majority of their income from banking activities.

The list includes general insurers IAG and Suncorp, which have proved their pricing power over the past 12 months in a duopolistic market structure by passing on the impact of higher reinsurance costs to customers in the form of double-digit premium increases.

The list also includes companies that derive the majority of their fees from asset balances (IOOF, Platinum, Henderson Group and AMP). The asset balances, from which they derive their fees, should swell in an inflationary environment. Then there are the sector specialists such as ASX, Challenger and IMF. While each faces increased competition in the coming years, each has a strong market position that should allow it reprice its services.

Collectively, these stocks should offer some income protection in a rising inflation environment, which would burst the current debt market bubble.


Stewart Oldfield is a research analyst at InvestorFirst Securities.

This article is the latest in our series The Yield Chase. To read other articles in this series, click on the story links below.

Six golden rules to maximise equity yields

A new road to yield growth

Money in the non-banks

BYO risk analysis on MYOB’s issue

Hitting the yield switch

Banks’ battle zone will crimp yields

Running out of dividend steam?

Fixing for a high yield fix

Taking a defensive yield tack

Cashing in on term deposits

Shopping for yield in Woolies’ property float

Telstra’s high-speed yield connection

Trustees seek yield safety

Yield spotlight shines on REITs

Hunting in US property