The lost decade for Australian shares: but don’t forget the income!
6 January 2017: In a recent article from the Australian Financial Review, the writer laments about the lack of capital growth from the Australian share market over the past 10 years. And indeed we believe he is correct. Over the 10 years to the end of 2016, the ASX/S&P200 price index has tracked predominantly sideways, as can be seen in Chart 1 below. In price terms it started where it finished, and still hasn’t got back to its pre-GFC highs recorded on November 1 2007. But equity investing is not all about capital growth. Yes we do like to think of equities as growth assets that appreciate over time, but they also can generate income.
Chart 1. Australian shares over the past 10 years to 31 December 2016.
Many shares pay dividends, and in Australia, those dividends may also come with franking credits which can be valuable for Australian investors. Accumulation or total return indexes calculate the total return including dividend income. When one adds in dividend income, the Australian S&P200 has actually returned 4.5% p.a. over the past 10 years to 31 December 2016, not a great return in our opinion but certainly better than 0% for capital growth. When compared to other forms of income, we believe it rates reasonably well, as highlighted in Table 1. The average official overnight cash rate averaged 3.8% p.a., whilst the average 1 year term deposit interest rate averaged the same 4.5% p.a. as the dividend yield, both over the same 10 year period.
However, the 4.5% p.a. term deposit income didn’t include franking credits, which the dividend income stream did. Australian pension phase superannuation investors get a full refund of franking credits, so for them, franking credits represent extra income. Using the S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) we calculate that franking credits have increased the total return for tax exempt investors like pension phase super, charities and low income Australian investors by 1.6%p.a., giving a tax exempt total return of 6.1%p.a., over the 10 years to 31 December 2016. Chart 2 highlights the difference in return from an investment in the Australian S&P 200 price index, ASX 200 accumulation index and ASX200 accumulation index including franking for tax exempt investors.
Table 1. Returns to Australian cash and shares – 10 years to December 2016
Chart 2. Australian S&P/ASX200 cumulative returns with and without dividends and franking credits – 10 years to 31 Dec 2016 based on investment of AUD$10,000.
Chart 2 highlights that in total return terms the Australian share market has passed the pre-GFC highs whether one includes franking credits or not.
Evaluating Managed Funds
This short note has highlighted the importance of considering both income and capital gains when evaluating the returns of shares. Whilst we believe share prices in Australia have gone predominantly sideways for the past 10 years, total returns including dividends have been positive, with cash dividends before franking averaging 4.5%p.a., and returns for tax exempt investors including franking credits averaging 6.1%p.a. over the 10 years to 31 December 2016.
We also note that similar but more complex considerations need to be taken into account when evaluating share based managed funds. Managed funds generally must distribute all the income they earn each financial year, and this includes not only dividend income and franking credits, but also includes distributing any realized net capital gains. Focusing simply on unit price changes can be very misleading when managed funds distribute income and net realized capital gains. Managed funds are generally required to distribute realized gains, which lowers the unit price, but share price indexes do not distinguish between realized and unrealized capital gains. So it is vitally important to add back in all distributions when evaluating the returns of managed funds. This is the case even if investors elect, where possible, to reinvest income in a managed fund. The reason being is that this reinvestment isn’t reflected in the managed fund’s unit price, rather it is reflected in the number of units held by the investor.
And it is vitally important to incorporate income for income focused managed funds, as they have the potential to generate more income than the market. Ignoring income (including franking credits) would thus greatly penalize the returns of an income orientated investment like the Plato Australian Shares Income Fund (the “Plato Fund”). Since inception to 31 December 2016, the Plato Fund has generated 6.5% p.a. income (9.0% p.a. income including franking credits) after fees, which is more than the 4.5% p.a. income (6.1% p.a. including franking credits) that its benchmark S&P200 index generated over the same period. The Plato Fund has also generated a net (of fees) total return of 14.0% p.a. whilst its benchmark generated 12.3% p.a. over the same since inception period.
So we believe it is important to account for income when evaluating share investments, be they direct shares or investments via managed funds. Dividend income and Australian franking credits are an important part of the total return for share investments. In fact, for the last 10 years to 31 December 2016, income has represented all the return from Australian S&P/ASX200 Index.
 Australian Financial Review – ‘ASX investors brace for lost decade’ 2/1/2017
 Source: RBA. For term deposits we used “Retail deposit and investment rates; Banks’ term deposits ($10000); 1 year”
 Plato Fund inception date is 9 September 2011. Past performance is not a reliable indicator of future performance.
 S&P/ASX200 Accumulation Index (including franking credits).
Plato Investment Management Limited ABN 77 120 730 136 (‘Plato’) is a Corporate Authorised Representative (No. 304964) of Pinnacle Investment Management Limited ABN 66 109 659 109 AFSL 322140.
Past performance is not a reliable indicator of future performance. Any opinions or forecasts reflect the judgment and assumptions of Plato and its representatives on the basis of information at the date of publication and may later change without notice. Any projections contained in the information are estimates only. Such projections or estimates are subject to market influences and contingent upon matters outside the control of Plato and therefore may not be realised in the future. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice relevant to their particular circumstances, needs and investment objectives.
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