Yields in surprising places

PORTFOLIO POINT: With interest rates falling and stock prices rising, investors will experience yield compression in 2013. But there will still be good opportunities.

As we come to the end of the year, Eureka Report’s series on the yield chase comes to an end as well.

Readers would be aware we have covered a wide range of different angles and views on how the chase has played out, and links to the full list of commentary is at the bottom of this article.

Obviously the theme of yield, and the places it was and is available for investors in 2013, has been the linking force between not only the series of articles – but the movements of the market as well. However, some of these movements, and some of the places where yield has become available in recent months, have not been easy to predict.

Collecting the full series together, it becomes apparent that investors have found yield in all sorts of places – both likely and unlikely. This article takes a look back at the series, and notes the key points and statistics for investors to take away.

The joys of the market

The yield story really begins with interest rates – but it ends up in the market.

With the Reserve Bank’s official cash rate at an equal-record-low 3%, and expected to fall further in the year ahead, the yield available from cash and term deposits has fallen sharply. Rates for savers are now barely above inflation in many places, and the crunch has forced investors looking to make even a modest 5% back into the market.

Robert Gottliebsen explains that term deposit returns have had the brakes put on by a range of competing factors. But he suggests locking in yields where possible for longer terms in the new low-rates environment, and shopping around some of the bigger banks’ online subsidiaries such as NAB’s UBank for the best deals.

Despite the coming changes to bank capital requirements under BASEL III, which make deposits more valuable to the banks and could see competition to attract long-term money, deposit rates are very low and set to go lower.

In a broader effort to maintain profitability, the majors have been passing on a larger proportion of the RBA’s rate cuts onto depositors than to borrowers. Term deposits are bearing the brunt of the banks’ tightening interest rate spreads.

Highlighting this, the latest data from the Australian Taxation Office shows that self-managed super funds swung back to holding more listed shares than term deposits in the September quarter.

Many people shaken by the sharemarket tumbles of late 2011 and early 2012 were staying out of equities by the middle of the year – but that proved to be where many of the strongest yields (as well as the subsequent strongest gains) were to be found.

The banks and Telstra

Banks led those stockmarket gains in 2012, as the chase for yield saw buyers seeking strong and stable dividends. The demand has pushed up the price of stocks which offer such dividends – helped by low official rates and poor returns from savings.

As a result, the big four banks outperformed the stockmarket by more than 7% this year, by offering buyers dividend yields of 6-7% (or close to 10% after the franking credit boost).

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But it would have taken a brave investor to pile money into bank shares at the start of 2012.

The world was still in the middle of the European sovereign debt crisis – some people were actually running competitions on the best way for Greece to leave the euro – while the US faced a shaky recovery and a Presidential election year.

Instead, Europe didn’t blow up, the global banking system wasn’t shaken up, and dividends here were maintained or raised. The Australian banks were certainly one of the yield ‘surprises’ of 2012.

Along with the banks for the rise was Telstra (TLS). Flush with money from a federal government deal relating to the National Broadband Network – worth up to $11 billion for the company if it all goes ahead – Telstra’s dividends suddenly had something of a floor put under them. The resulting yields of more than 10%, effectively government guaranteed, led to Telstra becoming one of the best large-cap performers on the bourse.

Telstra shares rose more than 30% in 2012, comparable with the strong price performance of three of the big four banks, and have gained roughly 60% in the past two years.

Robert Gottliebsen explains that while the yields are certainly attractive (and with franking remaining at about 9%, even with the price appreciation), the company faces risks from flattening earnings, and reaching a point where the quest for free cash flow could affect the performance of the company.

He wrote: “You can’t run a telecommunications operation longer term on the basis that you simply distribute to shareholders all the free cash flow generated by the business.” Indeed, the yield story for Telstra is still going, but it may soon be drawing to a close.

REITs and property

Another major surprise for many investors has been the resurgence of listed property, which performed disastrously through the years of the global financial crisis.

Ian Verrender explains just how far the real estate investment trust (REIT) sector has come in reforming itself, and points out it now provides one of the few places where dividend growth is being backed up by earnings growth.

He noted that in 2006, REITs were paying out an average 103.1% of earnings – but this has since been reduced to a more sustainable (although still attractive and high) 81.7% of earnings on average. The gearing and the weaker elements of the trusts’ fundamentals have been minimised and the sector has bounced back.

Louis Christopher says that the outlook for property is generally positive on two counts – the chase for yield and the low-interest rate environment.

He points out that retail property faces risks at the moment from the structural and cyclical weakness in the retail industry, but that yields are high as a result. Residential property tends to take a boost from low interest rates, while yields in industrial property are between 8% and 11%, and office property between 6.5% and 7%.

The sector may also see increased takeover activity in the coming year as demand rises – evidenced already by the recent $3 billion bid by GPT Group for a substantial portion of Australand’s assets.

Other surprises and looking ahead

There were plenty of other places where investors were seeking yield as well.

Stewart Oldfield highlighted some of the opportunities available from the non-bank sector, particularly when it comes to protecting from the possibility of rising inflation.

He explained how insurers like IAG and Suncorp were able to use their market position to pass on premium increases to customers, thus helping to maintain relatively high yields. Financial services companies such as AMP, IOOF and Platinum Asset Management also provide yield surprises.

“The asset balances, from which they derive their fees, should swell in an inflationary environment,” Oldfield explains.

Listed Investment Companies, or LICs, also provided a yield surprise. Ian Verrender found that while they generally deliver higher yield and a greater degree of franking credits than managed funds, they are a part of the market that is too frequently overlooked.

Then there was the $13-billion-plus of hybrid securities issued in the year, as well as the yield opportunities offered by a widening range of fixed income products. Elizabeth Moran wrote several revealing articles on the yield picture, including where larger or sophisticated investors can benefit from the over-the-counter fixed income market.

One thing sure to surprise investors on the yield chase, however, is the future.

At some point the chase for yield will end, as share prices rise and dividends compress. Already Telstra, and the three major banks apart from NAB, have seen yields diminished by demand from the chase. This is predicted for listed property and other sectors too, as earnings growth to support dividend and price growth is not easy to come by.

Analysts suggest it may be a year for growth stocks again, and the mining sector is increasingly back in favour.

To read other articles in this series, click on the story links below.

Property will make a return in 2013

A fixed-income yields blitz

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