Income strategies expected to surge as dividends improve

  • Buybacks returning as era of cautious balance sheets ends

Income-based strategies are likely to become more appealing to investors as companies restore their dividends and come under increasing pressure to pay out their cash piles, according to Russell Investments.

“Now is a great time for investors to consider moving back into Australian shares. With corporate balance sheets being restored, dividends are returning to normal and overall yields are competitive against term deposits,” said Scott Bennett, portfolio manager at Russell Investments.

This reporting season saw an increase in dividends for the first time in 12 months, with the majority of companies delivering dividends in line with or better than market expectations – a welcome relief from the previous two reporting seasons where many companies cut their dividends to conserve cash.

The banking sector increased the most, up 32% over the previous period. Many resource companies resumed dividends as well, signaling renewed confidence in commodity and energy pricing.

“We are seeing a turning point for dividends. As a result we expect a rise in income-based strategies as the market heads into a period of lower growth where a greater proportion of investors’ total returns could be driven by dividend income,” Mr Bennett said.

Mr Bennett explained that income strategies will be particularly useful for SMSF investors as they begin implementing their transition to retirement strategies.

In fact dividend yields are currently performing better than 90 day bank bills. Based on IBES consensus forecasts the Australian market is currently yielding a gross of 5.4% (after franking credits) compared to 90 day bank bills which are currently yielding 4.8%.

The Russell Australia High Dividend Index, an index that is representative of a high yield strategy, is currently yielding above the market average at 6.7% (gross) based on IBES consensus forecasts. The index selects companies that have a high expected dividend yield but which also meet other characteristics, including a history of paying dividends; dividend growth; and consistent earnings.

Buybacks are back

According to Russell, share buybacks is another area SMSF investors should consider for income strategies. These are set to increase as companies move away from conservative balance sheets that’s characterised the last couple of years.

“Following an extended period of capital-raisings from Australian companies, we have started to see a reversal in the trend with the likes of Woolworths and CSL recently returning capital to investors,” said Mr Bennett.

Over the two calendar years 2008 and 2009, Australian companies raised more than $110bn, according to the ASX. Australian companies had 6.5% of their assets in cash at 30 June 2010; compared with 4.3% at 30 June 2008, according to Macquarie.

However excess cash can have a negative effect on a company’s return on capital, so Russell foresees increasing shareholder pressure for companies to either put the cash to work, through M&A activity, or return it to shareholders via a special dividend or buyback.

“Woolworths’ recent off-market buyback is an example of an attractive strategy for SMSFs, as the majority of the buyback price was treated as a fully-franked dividend, therefore allowing significant tax benefits for investors,” Mr Bennett said.

To help facilitate this growing investor appetite, Russell Investments has developed several investment strategies that have been specifically designed to extract a higher level of income from an Australian equity portfolio. These strategies include Australia’s first ever dividend-focused Exchange Traded Fund, Russell High Dividend Australian Shares ETF (ASX ticker code – RDV).

It is also looking to launch a multi-manager income fund that will combine several unique income-focused strategies in a diversified portfolio.

“We have seen a positive season for dividends, and now is the time for investors to consider how a dividend approach can benefit them,” Mr Bennett concluded.

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