Rudi’s View: More Choice For Income Hunters

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Nov 10 2022

In this week's Weekly Insights:

-More Choice For Income Hunters
-December Index Review Preview
-Conviction Calls
-AIA Investor Day In Sydney

By Rudi Filapek-Vandyck, Editor FNArena

More Choice For Income Hunters

The year of the Grand Yields Reset, otherwise known as probably the worst bear market for global bonds - ever, is starting to deliver investors genuine alternatives for regular income outside the share market.

This is a major change from recent years when a common phrase used on Wall Street was that of TINA - There Is No Alternative (to equities).

Increasingly, asset allocators and strategists are again warming towards government bonds and even cash deposits as implied returns (through income) have become competitive with stocks, and at a much lower risk profile.

Investors are being reminded that economic recessions, expected in the year ahead, bring along a lot of uncertainty for corporate profits and valuations, which, all else remaining equal, lifts the overall risks for individual companies, and their dividends.

Bonds traditionally benefit from tougher economic conditions, with both inflation and central bank tightening expected to change course over the year ahead.

A recent strategy update by Wilsons highlighted several fixed income alternatives investors might consider as a lower-risk option for their non-active cash on the sideline, including:

-JCB Active Bond Fund (CHN0005AU)
-Western Asset Australia Bond Fund (SSB0122AU, BNDS)
-iShares Core Composite Bond ETF (IAF)
-Floating rate hybrids

In addition, Wilsons strategists also highlighted the following alternative asset allocation options:

-AMP Capital Core Infrastructure Fund (AMP1179AU)
-BetaShares Gold Bullion $AU hedged ETF (QAU)
-CIPAM Multi-Sector Lending Fund (HOW6713AU)
-Alium Market Neutral Fund (DCA7894AU)
-Yarra Private Capital Discovery Fund

The strategists also did not hesitate to recommend investors use term deposits for any cash not allocated. Quant analysts at Citi recently went one giant step further; in their view, cash is back as a genuine asset, alongside all the usual suspects of property, stocks, and fixed income.

Admittedly, the situation for investors in Australia is not quite the same as for peers in the US or New Zealand where government bond yields are currently above 4% (the ten year yield is 4.50% in New Zealand) with the Aussie ten-year yielding circa 3.85%, not too dissimilar to bond yields in Canada and Great Britain.

Plus, of course, income derived from Aussie shares on average is among the highest in the world, today's average dividend yield of 4.8% well exceeding the sub-4% on offer through domestic government bonds (franking not even included).

However, the underlying message remains the same: for those investors looking to diversify and to spread risk, or who feel uncomfortable with the outlook for the share market, alternatives elsewhere are steadily becoming more attractive, and expected to receive a boost when central banks stop hiking rates.

Yield alternatives are equally popping up through Exchange Traded Funds (ETFs) with the FNArena/Vested Equities All-Weather Model Portfolio recently adding the Vanguard Australian Property Securities Index ETF ((VAP)). This selection of 31 ASX-listed REITs, property owners and developers has been sold off aggressively this year on the back of rising bond yields.

According to indications published by Vanguard on the dedicated website, the implied dividend yield on offer is now 5.1% with individual risks spread across Goodman Group ((GMG)), Scentre Group ((SCG)), Dexus ((DXS)), Stockland ((SGP)), Charter Hall Long WALE REIT ((CLW)), National Storage ((NSR)), Waypoint REIT ((WPR)) and 24 others, of which many are household names among Australian investors.

What about Australian shares?

This year's bear market for bonds has equally thoroughly shaken up the local share market.

Viewed from the top down, the ASX200 is not too far off from where it traded at the start of the calendar year, but underneath a Big Reset in valuations has occurred, reducing the average PE ratio closer to 13x from 17.7x in January and from above 20x in 2020.

As a result, the average forward-looking dividend yield for the ASX200 has now risen to 4.8%. For comparison; the long-term average since 2006 is 4.6% but in the two years preceding that percentage had been fluctuating between 3.5%-4% as banks and other companies had been cutting dividends while average valuations were much higher.

In normal circumstances, insofar they are ever genuinely 'normal' on the Stock Exchange, investors are usually reminded above-average dividend yields also imply above-average risk.

History shows the worst investment experiences usually stem from buying into high-yielding shares before the company announces a reduction or suspension of its dividend payout.

This time around, the Australian share market has a number of unusual set-ups that deserve to be highlighted.

Super Profits Facilitate Super Dividends

Resources companies, because of their extreme leverage to economic and sector-specific momentum, seldom feature highly on investors' radar when it comes to options for sustainable, regular income from shares.

But iron ore companies have proven in recent years that when prices surprise to the upside, and stay higher-for-longer, this generates an absolute cash bonanza for the companies involved, and their shareholders.

As such each of BHP Group ((BHP)), Rio Tinto ((RIO)) and Fortescue Metals ((FMG)) had moved into the Global Top Ten of dividend payers. Though with the price of iron ore pretty much halving since March, those dividends will not be repeated from here onwards.

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