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A new strategy for yield-hungry investors

By Christine St Anne

Low cash rates continue to challenge income-seeking investors. With the current cash rate of around 2%, term deposits are now just a little under 3%– well down from the 6% to 7% highs of 2011.

In such a low-interest environment, investors have had to rethink their income exposure away from term deposits.

It’s not surprising that Australian companies paying good dividends have been popular with yield-hungry investors. Companies like the big banks and Telstra have provided investors with dividend yield of around 6% to 7%. These stocks are now a big part of most income targeted portfolios. 

A range of exchange-traded funds (ETFs) can also meet the needs of income-seeking investors. Growth and innovation in the ETF market now means investors can invest across a range of asset classes, including fixed-income. Using these strategies can provide investors with the opportunity to enhance the income in their portfolio. 

Within the equities asset class, investors can access high-dividend ETFs which focus specifically on companies that pay strong and reliable dividends. Besides the dividend favourites such as the major banks, these ETFs can invest in a number of companies that also deliver strong dividend yields such as Wesfarmers or Telstra.

Overcoming the yield trap 

Often in the drive for yield, investors can fall into a ‘yield’ trap. This happens when the yield of a company rises simply because its share price has fallen sharply. 

One timely example of this is the BHP story. A number of factors caused BHP’s share price to plummet over the past few years. The further the share price would fall, the higher the dividend yield would seem. But as we’re all aware, BHP cut  its dividend at its AGM earlier this year. While it was arguably the right business decision, it was a perfect example of a falling share price causing a ‘dividend trap’.

A key rule to income investing is that dividends need to be supported by a company’s earnings, and therefore it’s crucial investors stick with companies positioned to deliver sustainable earnings.

The methodology and research behind these high-dividend ETFs can actually recognise this risk and focus on sustainable dividend paying companies.

For example, the iShares S&P/ASX Dividend Opportunities ETF (ASX: IHD) has been developed to give investors access to Australian companies that pay high but sustainable dividends.

In a bid to minimise the risk of dividend traps, iShares implemented a new strategy to the IHD fund. A ‘momentum filter’ in the ETF’s process picks up the range of change in a stock price. iShares believes that the share price information will identify dividend traps more quickly. 

Wide approaches to income 

A key advantage to high-dividend ETF strategies is that investors can access a range of quality dividend-paying companies under one strategy. 

By investing in an ETF like IHD, investors can access quality dividend-paying companies in one transaction. 

Income-seeking investors can also look at multi-asset strategies such incorporating fixed-income asset class. Bonds and credit can all play a role in an income portfolio. 

Fixed-income ETFs not only generate income through coupons to investors, but also play an important defensive role in a portfolio. These assets can provide a counterweight to equities in an investor’s portfolio. 

Investors can also seek higher yield strategies from this asset class such as global high yield or emerging market credit. ETFs offer an efficient and cost-effective ways to access these strategies. In one trade, the iShares Global Corporate Bond (AUD Hedged) ETF gives investors a currency-hedged exposure to an index of thousands of corporate bonds from issuers in a number of industries and geographies. 

Ultimately, Australian investors can now build a diversified exposure to emerging market bonds, high yield corporate bonds and high-dividend paying Australian equities in just a few trades. This gives them access to diversified sources of return while minimising risks across a number of asset classes, sectors, credit qualities and regions.

 

 

Published on: Thursday, March 17, 2016

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