News & Insights

Livewire Q&A: Another way to yield 6%

With franking credits in Labor’s sights, and half of Aussie income coming from a handful of stocks in sectors under duress, we asked Dan Pennell, Senior Portfolio Manager at Plato Investment Management to outline what’s on offer through global equity income investing.

Q1: How does global equity income stack up against the other income options?

Whilst long-term income from a passive allocation to global markets is around 2% per annum, active global equity income like the Plato Global Shares Income Fund has delivered 6% income after fees. This stacks up well versus traditional income products like cash and bonds, because even though yields on these products are rising, they are only rising slowly. The US is leading the tightening cycle, but even there cash rates are only just over 2% and bond yields just over 3%. Australian cash rates seem doggedly stuck at 1.5% with the market only expecting a very modest tightening cycle over the next few years.

Q2: How does the income from global shares compare to that from Australian shares?

Global shares yield just under 2%, whilst the domestic market offers three times that once you include franking credits. However, global income strategies that actively seek out income can produce around a 6% yield, from a much more broadly diverse base. Australian income is very concentrated, with 6 stocks (the big 4 banks, Telstra and BHP) producing half the income in 2017, and the ALP has a proposal that puts in question the value of franking for some investors. So from a risk diversification perspective, spreading your income risk globally makes a lot of sense.

Q3: How would the comparison change if Labor’s proposed changes to franking credits are implemented?

Franking credits will still remain under the current ALP proposal and will be able to be used to offset tax payable, but for some investors, like pension phase SMSF members, they may no longer receive a refund of the franking credits. For such an investor, the yield on Australian shares effectively falls to around 4.3% for the S&P200 Index. Under this scenario, the 6% generated from the Plato Global Income Fund becomes increasingly appealing. This proposal has certainly increased investor interest in the strategy. For an income investor, this level of income removes that natural barrier to global. In addition, you participate in other benefits including diversification and, over recent years, return.

Q4: What are some of the benefits of investing offshore for Australian investors seeking income?

Aussie investors have a significant home bias and for those focused on income it’s no different. When first moving here from London the high level of income available domestically was immediately apparent. But so too was the concentration risk we mentioned above. In our discussions with clients around the country we’ve learnt many hold the 4 banks and Telstra for income. Their recent underperformance and Telstra’s reduced dividend demonstrate the risk of concentration to both return and yield.

Going global provides diversification and access to countries and sectors that are hard to gain exposure to domestically. If I asked you to name an IT company it’s pretty likely it would be offshore. In recent years global markets have also offered increased return.

A final thing to think about is the diversifying nature of currency. Despite common perceptions, currencies can diversify. Positive correlation means when markets fall the AUD often falls too, boosting domestic returns.

Q5: Your portfolio has a high level of turnover, could you explain why this is and what benefits you’re aiming to achieve?

Our turnover is linked to how we generate income. A simple buy and hold strategy may deliver 3-4%, but you don’t need to own a stock all year to get its dividend. That’s particularly the case in continental Europe, where many stocks pay a single annual dividend.

So by actively trading our portfolio we can rotate between dividend paying stocks, substantially increasing income without having to take extreme tilts to high yielding individual stocks. We also benefit from what we call dividend run-up – the tendency for dividend paying stocks to outperform their local markets in the lead up to their dividend ex-date.

Q6: What are some of the other strategies you use to increase the level of income achieved?

We have a natural tilt to higher yielding stocks, but the main generator of our higher yield is our active dividend rotation strategy. Importantly, we don’t use derivatives to enhance income, as this usually comes at the expense of capping the upside, an upside that is what most investors want from their equity exposure.

Q7: What are some of the indicators that a high-yield share could actually be a value trap?

As an active manager, we forecast the income for all stocks in the universe and indeed the probability of a cut from companies where we think that income is at risk.

Without giving too much of the secret sauce away, we have proprietary models that look at a number of factors to isolate strong businesses, generating good levels of yield that have lower risk of a cut. In our view, going blindly overweight the highest yielding names is not the best way to maximise either income or total return. Importantly, as an active strategy we are forward-looking and risk aware.

Q8: Are there any specific geographies or sectors where you’re finding plentiful income opportunities today?

Traditionally certain countries and sectors, for example, Spain or utilities, generate higher yield, but we wouldn’t necessarily recommend owning a global portfolio stuffed full of Spanish utilities and Italian banks. However, when you go to the stock level there are opportunities everywhere. If we look at the broad universe, dividend growth is strong. Q3 2018 dividends increased 13% versus the previous corresponding quarter.

The largest sector increases were in materials (+34%) and IT (+22.5%). In developed markets over 1800 companies increased their DPS; a lot of opportunity!

Interestingly there is some cyclicality in yield through the year. Q2 is a much larger dividend-paying quarter, driven by European stocks. The total dollars paid in Q2 were 50% higher than Q3 this year.

Q9: What are some of the biggest myths and misconceptions about investing offshore?

The two biggest myths we come across are: i) that there is no income offshore and ii) we just don’t understand global stocks.

In response, even a passive allocation to countries like Spain, UK, Portugal can yield 4 or 5%. In our universe there are over 650 stocks paying high yield (4+%). Over a third of them pay in excess of 6% yield. There certainly is income if you know where to look.

In terms of the second point, yes investors understand Australian stocks better, unfortunately, they also understand the pressures the big four banks and Telstra are currently under.

Yet they probably have a pretty good understanding with plenty of global yielders too: imagine waking, shaving with Gillette (Procter & gamble), spreading marmite (Unilever – give me a break I am a pom) on your toast, as you check your Apple phone, then jump in a Ford Focus… Global stocks are all around us!

This article was original published in Livewire

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