Jason Kim, Portfolio Manager and Senior Analyst at Nikko AM Australia explains why ‘buy and hold’ strategies of traditional high-yielding stocks may not be the best investment strategy as Australia’s population ages and the chase for yield continues.
Background
Australia’s demographic shift is having a significant impact on Australia’s financial markets. The search for income in a low interest rate environment has seen investors, particularly the rapidly growing self managed superannuation funds, develop a love affair with high-yielding stocks.
With bond yields expected to stay at relatively low levels, the demand for high-yielding equity strategies is likely to continue. Investing in just a handful of traditional high-yielding blue chip stocks and holding onto them, may however expose investors to greater volatility than they are prepared for. An actively managed portfolio, comprising a diversified selection of traditional and non-traditional high-yielding stocks that are continually assessed for value, can help reduce this volatility.
How has Australia’s population changed?
Over the past 100 years or so, Australia’s population structure has changed markedly. In 1911, it was a typical pyramid shape – bottom heavy with the population skewed to younger age groups. By 1961, the pyramid had widened reflecting the growth in Australia’s population, particularly in the 0-14 age bracket, reflecting the birth of the baby boomers post World War 2.
By 2004, the pyramid had changed shape altogether, particularly around the middle, with the baby boomers now aged in their 40s and 50s. By 2051, the Australian Bureau of Statistics (ABS) is projecting Australia’s population structure to be more top heavy, with people aged 80 plus representing a significant percentage of the population – more than those being born (ie 0-4 years of age).
What’s causing the change in shape?
In addition to the ageing of the baby boomers, increasing life expectancy is another contributing factor causing the shift in Australia’s demographic structure. According to the ABS, the average life expectancy for females born between 2010 and 2012 is 84.3 years of age, up from 58.8 for those born just over 100 years ago in 1910. The average life expectancy for men is 79.9, up from 55.2.
A lower fertility rate is also playing an important role. Australia’s fertility rate has fallen sharply since the early 1960s. A fertility rate of 2.0 (ie two children) is considered to be the replacement rate for the population – two children replaces two parents. Australia’s fertility rate has been below 2 since the mid-1970s.
Should we be concerned?
While the 65 plus age group as a percentage of the total population is expected to increase to 27% of the population by 2050 (from 15% currently), of greater economic significance is the forecast decline in Australia’s ‘inverse dependency ratio’. The ratio of the working age population to dependents (defined as those aged less than 15 years of age and 65 plus) is expected to fall from around current levels of 2 to 1.5 by 2060.
A shrinking working age population has significant implications for the Australian economy and the share market. An ageing population places a financial burden on the economy through higher demands on public healthcare costs and social security from retirees; while tax revenue and consumer spending is dampened due to the lower proportion of the working age population.
Japan has experienced the demographic shift already and in a more pronounced manner due to negligible immigration, persistently low fertility rates and rising life expectancy. Currently, Japan has 25% of its population aged 65 plus. Over the last several years Japanese investors have been seeking high-yielding investments around the world due to low interest rates and an ageing population seeking higher income than what is available in their own country. The Australian equity market has been a beneficiary of this demand.
What impact are SMSFs having?
The rise in grey power is impacting the Australian share market quite significantly via the growth in self managed superannuation funds (SMSFs). According to the Australian Tax Office and Credit Suisse, SMSFs received an average of around $15 billion per financial year in net inflows over the nine-year period from 2003-04 to 2011-12.
What’s concerning, is that SMSFs appear to have a distorted asset allocation with a significant bias to direct domestic equities and property.
Anecdotal evidence suggests that the direct equity exposure is limited to the big four banks and a handful of blue chip high-yielding stocks. What’s more, SMSFs are continuing to buy these stocks, regardless of value or where we are in the market cycle.
The boards of companies are becoming increasingly aware of the growth and influence of SMSFs and their increasing demand for higher dividends.
As noted above, the demographic shift will potentially lead to lower economic growth. This, together with the increasing demand for higher dividends by SMSFs could exacerbate this problem as companies feel pressured to meet their demands – at the expense of investing in their businesses.
Does this mean dividend yield strategies will continue to outperform?
This demand for high-yielding equities has obvious implications for yield-driven strategies. Over the past 12 or so years, dividend yield strategies have outperformed the broader share market by a comfortable margin.
There is a strong correlation between the change in the number of retirees and the performance of dividend yield strategies. The yellow line in the chart below shows the percentage change in retirees (with the green line representing the forecast change) and the outperformance of dividend yield strategies (blue line). As the number of retirees has increased, dividend yield strategies have outperformed.
Sustained demand for high-yielding equities for at least the next two to three decades as the percentage change in the number of retirees continues to increase, suggests that dividend yield strategies will continue to outperform for quite some time yet.
An active, value-driven approach can help to navigate through the volatility
We would however caution against simply investing directly in a handful of well known high-yielding stocks and locking them in the bottom drawer. This is not an ideal way to invest, due to the risk that pockets of yield stocks may become more vulnerable to shocks as their valuations become stretched.
This risk is exacerbated by SMSFs, which tend to hold stocks directly in a relatively passive ‘buy and hold’ manner as well as invest in index funds and Exchange Traded Funds (ETFs).
To minimise the potential of a portfolio of yield stocks being prone to such vulnerabilities requires active analysis and continual valuation of stocks. Well-resourced active managers, such as Nikko AM Australia, who have yield strategies but with a focus on value, is one way for investors to help navigate through this potential volatile and uncertain period. It may come as a surprise to many investors but a large portion of outperformance in our high-yield strategies has actually been derived from ‘other’ non-traditional high-yielding areas where opportunities have arisen in specific stocks, rather than the traditional high-yielding stocks.
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Disclaimer: This material was prepared and issued by Nikko AM Limited ABN 99 003 376 252, AFSL 237563 (Nikko AM Australia). Nikko AM Australia is part of the Nikko AM Group. The information contained in this material is of a general nature only and does not constitute personal advice, nor does it constitute an offer of any financial product. It is for the use of researchers, licensed financial advisers and their authorised representatives, and does not take into account the objectives, financial situation or needs of any individual. The information in this material has been prepared from what is considered to be reliable information, but the accuracy and integrity of the information is not guaranteed. Figures, charts, opinions and other data, including statistics, in this material are current as at the date of publication, unless stated otherwise. The graphs, figures, etc., contained in this material include either past or backdated data, and make no promise of future investment returns, etc. Past performance is not an indicator of future performance. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided.
