Investment Ideas

Income Investing

The Case for Income Investing in Equities

As Australian life expectancy extends, investing for income is becoming increasingly important. However, returns from traditional income sources have been lacklustre – the average one-year bank term deposit rate in Australia is at a 15-year low at 0.60% p.a1 – pushing investors to rethink their current income strategy. 

At the same time, while seeking an adequate income stream to match their needs, investors are cautious about placing their capital at risk. Creating an income generating portfolio is as important and challenging as it has ever been. 

To maximise income potential, mitigate yield traps and gain some long term potential capital appreciation, we believe investors could:

  • Focus on selecting quality stocks with sustainable yield. With income from bonds ‘challenged’, investors could consider a strategy that applies a systematic selection of stocks based on well-defined characteristics, such as dividend persistence and sustainability, price performance and quality.  In turn, they may earn higher income with the potential for capital growth over the longer term.
  • Dynamically tap into high-yield income opportunities across sectors. Banks and resource sectors dominate the Australian market and have been the yield-play darling for years. However, as different sectors go in and out of favour the portfolio is rotated accordingly. 

In today’s low rate environment, equities can provide attractive stable income returns compared to cash or bonds. However, investors need to take into account that equities may be more volatile. 

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Index returns reflect capital gains and losses, income, and the reinvestment of dividends.

Why go Global?

In a persistently low-interest rate environment it has become increasingly difficult to find high-yielding fixed income assets onshore, especially while maintaining meaningful levels of diversification beyond Financials and Materials. We believe, based on years of data that investors looking for a more diversified equity income portfolio may benefit from exposure to high yielding global equities.

Here are five key reasons why investors should consider going global for income investing in equities:

  1. A bigger opportunity set. The Australian equity market represents less than 2.5% of the total developed global stock market capitalisation.2 To put this in perspective, that’s about the same size as Apple or Microsoft. By opening up to a global opportunity set investors gain exposure to a market that is in aggregate over 40 times the size of the Australian market.  
  2. Potential risk reduction. Australian companies have been historically ranked high globally in terms of dividend payout ratios, however they are also exposed to dividend cut risks. Dividend cuts can hit investors hard — not only with the prospect of lower income returns but also a depreciating share price. A highly selective global equity income strategy can help investors minimise this risk. 
  3. Uncommon diversification. A large proportion of dividends in Australia are contributed by a handful of Australian companies in Financial or Materials sectors. In a global dividend fund, by design there’s less likelihood that a few companies dominate, which can help reduce the impact of market volatility or a local economic downturn. Offset low bond yields. In a diversified portfolio, high-yielding equities can continue to help compensate for historically low bond yields in Australia and other developed markets. Growth opportunities. Investors in high yield equities may also capture capital appreciation over the long term. 

By diversifying offshore through a global income equity strategy, Australian investors can tap into the income-generating potential of some of the world’s most stable and profitable companies, while reducing risk through effective diversification across companies, sectors, markets, and regional economic cycles.

Despite the potential benefits, many Australian investors have a minimal allocation to international equities. Underpinning this home bias are a range of administrative and financial barriers that have traditionally frequently discouraged investors from accessing overseas markets. 

Sectors and weights shown are as of the date indicated and are subject to change.

Investing for Equity Income Through an ETF

An exchange traded fund (ETF) can be an effective way to access the income-generating potential of equity markets around the world.

In particular, global income ETFs remove the complexities of a direct investment. A global income ETF creates a reliable and diversified income stream through a single investment, and there is no need for investors to research, select, monitor or trade shares across unfamiliar sectors and markets.


SPDR Bond Compass - Quarterly Report

Needle in a Haystack: Selecting a Smart Beta Strategy in an Overcrowded Landscape

Interest in smart beta is growing –at the end of December 2018, there were 1,493 smart beta equity ETFs and ETPs globally. Within such a crowded landscape, investors need to conduct ample due diligence before selecting a strategy. This worksheet provides a thorough framework to consider when choosing the most suitable smart beta ETFs.

Source: Reserve Bank of Australia, as of 30 June. Series: FRDIRSAO10K, Retail Deposit and investment rates, Online Savings accounts

Weight of Australia in the MSCI World Index was 2.41%. Source: Factset, as of 30 June 2019.