Many have been sceptical of the so-called “yield trade” over the past three years. Strong gains in interest-rate-sensitive securities such as banks, utilities and listed property suggested it was time to take profits and chase cyclical growth stocks.
The Australian sharemarket’s recent bounce from its September low has some commentators recommending investors switch to growth-sensitive stocks such as beaten-up diversified miners. Again, that call is too early: portfolios should retain a defensive, yield bias.
I’m not convinced the October bounce in equities is the start of a much bigger rally into the new year. The market still looks range bound – 5,000 to 5,500 points seems reasonable – and there are few catalysts for it to break that resistance in the near term.
China’s economy is slowing, although not by as much as the bears argue. US equities look overvalued and the recent spate of giant global mergers and acquisitions is cause for concern, for it can signal a market top as executives and boards become bullish late in the cycle.
The Australian economy remains sluggish; expect another rate cut in the next six months, depending on whether the other banks follow Westpac’s lead with out-of-cycle rate hikes. Commodity prices and the Australian dollar still have further to fall. Corporate revenue growth, which has slowed to a crawl, will take time to recover.
That does not mean I’m bearish on the market or that good gains cannot be made trading Australian equities as they move within a range. For example, this column suggested using exchange-traded funds over the S&P/ASX 200 index when the sharemarket correction peaked in September, to participate in a likely bounce from the lows in October and beyond. So far, so good on that idea.
But the bigger picture is still the market grinding sideways as the global and Australian economic outlook slowly repairs. Our market, on a forecast Price Earnings (PE) of just below 15, is trading in line with the historical average. It’s neither expensive nor cheap, and does not have a lot of scope to absorb earnings disappointments if revenues slow further.
On that basis, long-term portfolio investors should retain a bias towards higher-quality defensive companies that offer sustainable yield. There’s still too much risk chasing cyclical growth stocks given a growing list of global and domestic economic threats.
Expected lower interest rates in Australia this year or next also strengthen the case for defensive yield stocks, relative to cash and other fixed-term investments.
Granted they are no longer as attractive: A-REITS and some utilities look overvalued and the banks have plenty of regulatory issues as they are required to hold more capital, which weighs on their return on equity.
Another option is using exchange-traded funds (ETFs) to gain exposure to a basket of higher-yielding securities. These smart-beta ETFs offer a slightly better yield than the market and better diversification than holding stocks directly.
More established yield ETFs include the iShares S&P/ASX 200 Dividend Opportunities ETF, the Russell High Dividend Australian Shares ETF, the SPDR MSCI Australia Select High Dividend Yield Fund, and Vanguard Australian Shares High Yield ETF.
Yield newcomers include the BetaShares Australian Dividend Harvester Fund, BetaShares Australian Top 20 Equity Yield Maximiser, UBS IQ Preferred Australian Dividend Fund, and the ANZ ETFS S&P/ASX 300 High Yield Plus ETF.
The ANZ ETF is a more straightforward option than some of the smart-beta newcomers that use options to enhance yield or are based on broking recommendations. The ANZ ETFS S&P/ASX 300 High Yield Plus ETF aims to replicate the performance of the S&P/ASX 300 Shareholder Yield Index (before fees and expenses).
It invests in the 40 stocks from the S&P/ASX 300 with the highest shareholder yield, which is a combination of common dividends and common share buybacks. The ETF screens stocks for liquidity, dividend growth and free cash flows. It aims to provide a defensive return from high-yielding stocks and a cyclical return from buyback companies, giving a growth element to the return.
The ANZ ETF’s focus on buybacks, the first ETF to do so in this market, is an important point of differentiation. Expect more companies to return cash to shareholders through buybacks in the next two years as they take advantage of depressed share prices and become more confident in the economic outlook. This could give the ANZ ETF a slight edge in providing a yield above the ASX 300 yield.
The ETF’s underlying index has returned 8 per cent over two years and 41 per cent over three (cumulatively) to October 20, 2015. Almost 40 per cent of the fund is invested in financial services and the annual management expense ratio is 35 basis points. As with all ASX-listed ETFs, this one is bought and sold on the exchange like a share.
Source: ETF Securities. At October 20, 2015
A concern is 17 per cent of the fund is invested in Woodside Petroleum and BHP Billiton. As noted earlier, it is too early to be bullish on cyclical growth stocks, but Woodside and BHP’s yields warrant inclusion in such an ETF.
I don’t expect the ETF’s underlying index to deliver the same returns in the next three years as it has in the past three. But in a market that is grinding sideways, a 6-7 per cent yield plus modest capital growth, from a diversified portfolio of high-quality companies, has appeal for conservative income-focused investors.
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at October 22, 2015.