News & Insights

AFR: Dividend ‘bonanza’ could ease the pain of lower rates

Top income funds are yielding double-digit returns but the trick for investors is to identify companies and unit trusts with sustainable performance.


A “dividend bonanza” is delivering 12-month returns on Australian income funds of up to 20 per cent, offering a compelling alternative to bank accounts for yield-starved investors after the RBA’s 25 basis point interest rate cut on Tuesday.

But the trick will be for investors to identify the companies and funds that can provide a sustainable return rather than dangle bait for the income-desperate or gullible.

By contrast, minimum rates on flexible and bonus saver accounts range between zero and 75 basis points, which is less than half the rate of inflation and a fraction of annual increases in health and fuel costs. Term deposits for a minimum $25,000 average between 1.53 per cent for one month and 2.55 per cent for five years. These are set to fall after the rate cut.

Many bonus and promotional accounts include a range of strict conditions from making a minimum monthly deposit and no – or very few – withdrawals to having a linked transaction account with the same bank or credit union or setting up an automatic savings plan with a regular debit from a linked transaction account.

Acadian Australian High Yield fund manager Joanna Nash, where the 12-month return is 13 per cent and 10.7 per cent over three years according to Mercer, says investors should focus on funds that deliver sustainable, stable yields by targeting companies with a record of increasing dividends, attractive earnings and disciplined distributions in line with cash flows and earnings.

“Investors need to combine yield with other considerations, like risk and return,” says Nash. “Investors who want yield typically want to reduce risk and protect capital compared to the broader equity market. Looking at other aspects of a stock besides yield helps to make sure we are aware of these other factors and invest accordingly.”

The Martin Currie Australian Real Income Fund is the top performer over 12 months with a return of more than 20 per cent, according to Mercer.  It has returned more than 12 per cent over three years and nearly 16 per cent over five. Major holdings incude retail REITs and transport infrastructure.

Plato Investment Management managing director Don Hamson says falling cash rates mean returns on cash, term deposits and products linked to bank bill rates are likely to continue sliding.

Plato’s income fund is the top performer over three years with a return of 13.6 per cent, according to Mercer.  Plato has $5 billion under management.

“Retirees living off cash-linked income will struggle to make ends meet,” says Hamson. “It is very timely for retirees to consider their income-generating asset mix.

“Thankfully, retirees can continue to bank on receiving franking credits from Australian share investments.” (Labor, which lost the recent federal election, had threatened to abolished credits.)

Hamson says ALP’s threat to franking has caused some companies to “flush out excess franking credits” to the end of this financial year, providing Australian income investors – including retirees – with a record level of dividends, which might not continue.

Dividend increases have been largely concentrated in the resources sector. Traditional income stocks, like the big four banks and Telstra, are either maintaining or cutting dividends.

Leading economists such as Bill Evans, chief economist for Westpac Group, predict at least two more 25 basis point cuts, which would take the cash rate to below 1 per cent.

It’s great news for those wanting to reduce household debt, pay down credit cards (which are charging up to 30 per cent for cash advances) and pay off, or reduce, mortgages by switching lenders, some of which are dropping fixed rates below 3 per cent.

But, says Anne Graham, a financial adviser and chief executive of Story Wealth, it is “getting really tough” for the nation’s 3.8 million retirees, savers and others relying on interest income.

“For many the choice is either eating into capital to maintain your standard of living or giving yourself a pay cut,” she adds.

The danger, says Graham, is that yield-starved investors will be tempted to chase higher returns without fully understanding the increased risk to their capital.

For example, a growing number of offshore, unauthorised funds are targeting Australian investors with promises of bank account-style service with double-digit returns.

Paul Moran, principal of Moran Partners Financial Planning, says: “Taking on more risk is perfectly fine if the investor is informed and capable of understanding the risks involved in some investments, but unfortunately this is not always the case.”

Australian overnight cash rates and 10-year government bond yields were already trading at all-time lows before the Reserve Bank of Australia cut the official rate from 1.5 per cent. Ten-year bond yields were dipping below the 1.5 per cent benchmark.

Written by Duncan Hughes

Originally published in the Australian Financial Review.