Primary content begins:
Yield-hungry may be missing main meal.
Date: Wednesday, 22nd March, 2006. Source: The Australian Financial Review. Author: Adam Courtenay.
In an environment where company dividends have never been greater, it’s no surprise that investors are hungry for yield. Many shareholders want their income and they want it now.
Companies have been only too willing to oblige. The most recent reporting season has been typically magnanimous, with listed companies forecast to hand out a record $45 billion to shareholders during the next 12 months, eclipsing the $41 billion of payouts distributed in the past year.
Broadly speaking, yield investors typically go for banks and finance companies, infrastructure stocks and property trusts. Those seeking long-term capital growth are more likely to look at mining and resources shares, but there are no hard and fast rules.
Proponents of high-yielding products readily cite the sharemarket crashes of 1987,1991 and 2000 to justify their obsession with biannual payouts.
“There’s a large amount of older people who have been through these periods and are now holding income shares in tax-reallocated pension funds or low-tax super funds,” Noel Whittaker, managing director of Brisbane-based financial planner Whittaker McNaught, says.
“The fact is, they know they’ll get their income whatever the market does.”
Kevin Bailey, chairman of Money Managers in Melbourne, says: “If there’s an obsession with yield, then it’s a very healthy one.”
Bailey argues the focus on yield can be traced back to the advent of dividend imputation in the late 1980s. Under the imputation regime, investors receive a 30¢ in the dollar credit for share dividends already taxed at the corporate level.
“So a super investor who only pays 15 per cent tax, actually gets a cheque back from the Tax Office, while the higher rate-paying taxpayer — who normally pays 48¢ in the dollar — only has to pay 18¢.
Yet, a comparison of total returns of Australia’s 50 biggest companies’ stocks in the past year shows the dominance of resources plays, which typically have little or no yield.
Woodside Petroleum and Rio Tinto returned 73 per cent and 58 per cent respectively, and BHP Billiton returned 35 per cent.
Of the banks, which typically offer big dividends to shareholders, only Macquarie reached 30 per cent.
Although this is clearly only a short-term snapshot, it does suggest an obsession with total return may be a better proposition.
Ian Ward-Ambler, head of asset management at Goldman Sachs JBWere, says investors tend to mentally account for yield and capital differently, a distinction that may not always make sense.
“There may be something that is forecast to pay a 6 per cent yield and no capital growth versus something that offers a total return of 8 per cent with no yield,” he says. “Many retail investors opt for the yield.”
“There’s a lot of risk associated with investing and losing your capital is one. But it doesn’t necessarily follow that you’re more likely to lose your capital in a no-yield investment than a high-yield one.”
Ward-Ambler says there may be excellent reasons people pay attention to yield, but that’s not the whole story.
One of the risks with yield is that some companies finance some or all of their dividends from borrowings.
According to Moody’s Investors Service, companies’ free cash flow has plunged in the past year.
Alan Dixon, managing director of Dixon Advisory and Superannuation Services in Canberra, says: “Many have held out the promise of income, only to be unable to sustain it.”
“Australian Magnesium was sold on a high yield which was completely false. All the company was doing was giving some of a $100 million government loan back to the investor.”
The company was always going to have to repay the $100 million loan from profits – which never came.
Infrastructure funds that have proliferated in the past few years have been paying investors dividends partially through borrowings rather than through the underlying utility, he says.
“They pay a yield based on what’s called ‘accounting gains’ but actually the cash doesn’t exist.”
Dixon also cites mortgage funds and some of the extremely high-yielding mezzanine finance companies, the collapse of Westpoint being the most obvious example of “yields gone crazy”.
Michael Spurr, chief financial officer at Count Financial wealth planners, says there is a need for yield-hungry investors to understand the risk/return trade-off as well as the dynamics of companies.
“Telling clients to sacrifice short-term income now because capital growth is important is a hard concept to get across,” says Spurr. “Yields may be lower at a point when a company needs to grow, but eventually that will translate into a growing income stream.”
Supporting content begins:
Subscribe to our email newsletter:
Sign up to receive newsletters and other helpful updates from Income Solutions.