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Time for investors to diversify for dividends

Investors who are relying on bank stocks for dividends may need to look elsewhere as new measures mean they are likely to miss out on the equity income.

Investors who are relying on bank stocks for dividends may need to look elsewhere as new measures mean they are likely to miss out on the equity income.

Now is a great opportunity to diversify into other sources of high yielding equities including overseas shares.

The Australian Prudential Regulation Authority (APRA) has written to all banks and insurers expecting them to limit shareholder distributions in the months ahead, and instead use buffers and maintain capacity to lend and underwrite insurance.

  • APRA chair Wayne Byres says: “This includes prudent reductions in dividends, taking into account the uncertain outlook for the operating environment and the need to preserve capacity to prioritise these critical activities.”

    Will Baylis, portfolio manager at Martin Currie an affiliate of Legg Mason, says this may be the right time for investors to diversify their portfolio.

    “If you’ve just owned banks you are now in dire straits if that income is funding your retirement.

    “Whereas if you own a broad base portfolio like in the BetaShares Legg Mason Equity Income Fund, which has different industries and 45 names with a diversity of sources of income then bank dividends are less of a pertinent issue.”

    Kanish Chugh co-head of sales at ETF Securities agrees: “If you want exposure to banks, do it in a diversified nature. It is probably better to remove single stock risk and move into an income focused exchange-traded fund (ETF) in the Australian market but also diversify with looking at income producing equity ETFs in overseas markets.”

    Chugh says investors need to be aware of how the indexes are working and whether the dividend cuts are being taken into account.

    Macquarie Securities analysts expect banks to either reduce or suspend their upcoming dividends completely and look to reinstate it if conditions normalise, putting investors who are reliant on the income at risk.

    Macquarie says the reduced dividend could result in “a possibly diminished appetite from this group of investors, as well as yield-focused funds and yield ETFs, is prone to impact banks’ share prices further.”

    Despite this, funds such as BetaShares Legg Mason Equity Income Fund, ETF Securities S&P/ASX 300 High Yield Plus ETF and ETF Securities S&P 500 High Yield Low Volatility ETF are positioned to provide a better outcome for investors.

    The BetaShares Legg Mason Equity Income Fund is an actively managed ETF aims to provide investors with the benefits of high, growing income and franking credits combined with the potential for less risk than the overall share market.

    The fund has around 14 per cent weighting in banks which is not enough to worry Baylis and the fund should absorb a lot of the broader market losses.

    “It’s not accounting for 40 or 50 per cent of our income. Our objective for our equity income strategy is to generate yield including the full value franking and to grow the income above inflation.

    “We believe that the income in our portfolio may fall to 20-25 per cent but the broader market could fall up to 40 per cent.”

    Baylis says he sees good sources of equity income from APA Group, IAG, Suncorp, ASX and consumer staples such as Telstra, Coles, Woolworths, Inghams Chickens. He says even companies like Transurban are an opportunity for investors.

    “Transurban is seeing lower traffic numbers and will have lower distribution numbers but nowhere near as low as the market.”

    The top five holdings in the fund are AGL Energy, ANZ, Coca-Cola Amatil, Coles Group and IAG.

    The ETF Securities S&P/ASX 300 High Yield Plus ETF is a passive fund and offers exposure to the 40 stocks from the ASX 300 with the highest shareholder yield. The stocks have to meet certain quality and liquidity requirements.

    Chugh says: “The fund allows investors to spread out risk from an income side, investing in 40 stocks that are looking for income. This is safer than relying on a handful of stocks for income.”

    The top five holdings in the fund are Wesfarmers, Transurban, Woodside Petroleum, ANZ and Westpac.

    “Investors want to be exposed to overseas markets and that way they are somewhat protected is current crises,” Chugh says.

    ETF Securities S&P 500 High Yield Low Volatility ETF looks at the 50 highest yielding but lowest volatility stocks from the S&P 500.

    According to Chugh, the current index yield in the US is 6.6 per cent whereas the ASX 200 yield is around 5.5 per cent. “While you’re not getting franking you are getting higher yield.”

    At each semi-annual rebalance, the index selects the 75 highest yielding eligible shares from the S&P 500. From this selection, the 50 least volatile shares are included.

    The top five holdings are Iron Mountain, Altria Group, Philip Morris, Gilead Science and Williams Companies.

    Scott Kelly portfolio manager at DNR Capital expects company dividends to recover. He says the DNR Capital Australian Equities Income Portfolio is not immune in the short term but will recover within three years.

    Kelly and his team have been reviewing the investment cases for all DNR Capital’s holdings and revisiting dividend expectations and stress-testing.

    “We have been speaking directly with company management to understand how they are dealing with the impacts of disruption, reviewing balance sheets, and the likely impact on long-term cash flows, which underpin dividends.”

    Despite this, the banks and insurers can only issue a dividend at a reduced level and after robust stress testing and discussions with APRA.

    As for the recovery, Joanna Nash, portfolio manager at Acadian Asset Management says the length of the COVID-19 shutdown period will affect dividends and their recovery.

    “It also takes longer to recover than to fall, so it is likely that dividends may be lower for longer as balance sheet strength takes priority during reduced economic activity.”

    Nash recognises that many investors hold shares for both long-term capital growth as well as income and they are both likely to fall but cautions investors to steer clear traps.

    “For those that are long term shareholders it is important to keep in mind your long-term goals and the relevant asset allocation. This may require some rebalancing amongst your assets.”

    Due to the large fall in stock prices, many stocks have a very attractive historical yield which will not necessarily be reflected in the second half of the year.”

    As for bank dividends, Westpac and NAB have not made any decision in relation to its half year dividend. They expect to announce its decision with the half year results on May 4 and 7 respectively. ANZ and CBA have not yet responded to APRA’s announcement.

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