News & Insights

Time to review equity income options

There will be no change to the way franking credits are taxed, at least for the next three years, and investors who were considering changing their investment strategies to accommodate the change can relax.

Stocks paying high dividend yield and equity income managed funds will remain mainstays of many investment portfolios, especially for retirees and other investors on low income tax rates.

However, not all equity income strategies have worked well for investors over the past couple of years. Banks and telcos have lost ground, with the result that investors are getting income from those stocks at the cost of little or no capital growth in their equity portfolios. It may be time to review equity income options.

According to the latest Mercer Investment Survey, the top-performing Australian equity income fund is the Martin Currie Australian Real Income Fund, which produced a return of 16.9 per cent over the 12 months to the end of April. The fund has returned 14.7 per cent a year over the past five years.

The Plato Australian Shares Income Fund produced a return of 15 per cent over the 12 months to the end of April and 10.2 per cent a year over the past five years.

Other top performers include the Acadian Australian High Yield fund (up 13 per cent over 12 months) and Colonial First State Equity Income (up 10.8 per cent).

A number of the funds in the Mercer survey have been unable to keep up with the equity market benchmark, the S&P/ASX 200, which was up 10.7 per cent over the 12 months to April. The median return of the 19 funds in Mercer’s equity income universe was just 6.8 per cent for the 12 months

This underperformance is because equity income funds tend to have big holdings in banks stocks and telcos, which have been poor performers over the past year.

The Martin Currie Real Income fund has a different approach. It invests in listed Australian companies that hold “real assets”, such as property, utilities and infrastructure.

Martin Currie portfolio manager Ashton Reid says the characteristics of real asset returns, which combine the predictability of bonds and the inflation-linked growth of equities, makes them almost a separate asset class.

The breakdown of the portfolio is 50 per cent real estate investment trusts, 35 per cent utilities and 15 per cent infrastructure.

“These businesses tend to be independent of the business cycle, with the customer base for toll roads and electricity grids driven more by population growth. They also have pricing power that allows them to match changes in inflation,” Reid says.

Plato Investment Management managing director Don Hamson says that because capital gains tax is no impediment for low tax investors, such as retirees, the Plato Australian Shares Income Fund uses a very active strategy of “rotating” through dividends paying stocks to deliver high income.

The Colonial First State Equity Income Fund is an example of an equity fund that uses derivatives to modify the return on shares. The use of options is designed to increase the proportion of total return that is delivered as income.

Dividends payments rose last financial year. Corporate profits in 2017/18 rose by 8 per cent and dividend payments were up by more than 13 per cent. Ninety per cent of S&P/ASX 200 reporting June 30 full year results declared a dividend and of those reporting a dividend 70 per cent increased it.

Dividends rose again during the half-year reporting season. Fewer than half the ASX-listed companies that issued financial reports for the six months to December achieved an increase in profit, making it a disappointing reporting season.

CommSec’s reporting season wrap showed that a total of 138 companies in the S&P/ASX 200 Index released half-year financial reports over the past month and anther 31 companies in the index reported full-year results.

Eighty-three per cent of reporting companies declared a dividend, which was a little below the average of 86 per cent. Of those declaring a dividend, 58 per cent lifted the payout. A number of companies elected to pay special dividends and, as a result, dividends payouts rose by 11.7 per cent.


By John Kavanagh

This article was originally published in The Rub.