Five takeouts for advisers to enable a better understanding of dividends in the Australian market context.

A stock-take of Australian equity dividends from an investor’s perspective results in a number of conclusions. Max Cappetta, CEO of GSFM investment partner Redpoint Investment Management shares five key takeouts.

In the year ended 30 June 2022, shareholders were rewarded with more than $90 billion in cash dividend payments, a record level and an incredible turnaround from the previous two years. Further strong dividend payments are expected as we head into the Australian corporate reporting season in August 2022 despite the share price volatility experienced since the beginning of calendar year 2022.

Share prices are more volatile than dividends and, despite current market volatility, Redpoint expects a cash dividend yield of approximately five percent is expected from ASX200 stocks for the 2022-23 financial year. When compared to current term deposit rates of 1.45% for one year^[1], dividends should continue to be attractive to investors.

Takeout #1: The valuation readjustment continues

Interest rates are rising back to pre-pandemic levels, a situation that’s more than simply a ‘return to normal. Instead, central banks are fighting an old adversary, inflation, which has been dormant for more than two decades. This means rates potentially need to go higher than would be required for a ‘return to normal’ because they’re an important tool to curtail inflation, both as it is today and expectations for inflation in the future.

Equities are also being repriced for higher interest rates and, as a result, equity prices have declined. The US market has had its worst start to a calendar year in decades, falling approximately 20 percent. The Australian equity market has also fallen, approximately 10 percent year to date.

If inflation is seen to be hitting a peak, then expectations for the crest in this interest rate cycle will soften. If inflation is more entrenched than anticipated, interest rates will most likely move higher to counter it, which will have a knock-on impact on economic growth and equity pricing.

History shows that price adjustments typically overshoot fair value in both directions (figure one). We are now likely close to being at, or still slightly above, an ‘aggregate fair value’. This means a further 10-20 percent overshoot on the downside remains feasible at current estimates of forward earnings.  Despite this current valuation readjustment, earnings expectations remain reasonably solid for the 2022 calendar year and 2023 financial year at this stage.

Takeout #2: Earnings and dividend remain robust for calendar year 2022

The Australian economy was able to weather the pandemic better than most due to the unprecedented fiscal and monetary actions of government and the RBA. Listed companies were also conservative in 2020, cutting dividends and hoarding cash, while making good use of the available cheap debt.

Income seeking investors have been well rewarded in financial year 2022 with a record cash dividend harvest of almost $90 billion, almost 50 percent more than the ‘bonanza’ $62 billion paid in financial year 2021. Australian equity income investors were rewarded by iron ore miners and share buybacks, from companies including CBA, NAB, Westpac, Woolworths and JB HiFi. Some companies, such as JB HiFi and supermarket operators were distinct beneficiaries of COVID lock downs and were able to grow revenue, profits and dividends consistently since 2019.

Figure two highlights the enormous cyclicality in dividends by sector over the last seven years and expectations for the next two years.

Looking ahead, 2023 appears as though it will be slightly better again. What’s of greater interest, however, is the underlying dynamics in terms of the industries and companies actually growing their earnings, growing their profits and being able to maintain these dividend payments.

So although the equity markets have dropped in price, there haven’t yet been any strong negative revisions to earnings expectations for financial year 2023 thus far. The upcoming August reporting season is expected to report a robust financial year for 2022, however, it’s all going to be about the forward guidance companies might provide in terms of costs and profitability.

Redpoint forecasts that the materials sector is likely to have a strong year in terms of dividend payments in 2023, but it’s expected to be weaker than 2022. The real standout is the energy sector, the only sector to have posted a positive return on a year to date basis. The pricing of oil and gas, and particularly coal, is driving energy stocks to experience supernormal profits; therefore, they will be the companies with large dividend payments.

Investors need to be mindful of the volatility of commodities and the resources sector; while dividend payments may be attractive this year and next, investors need to look ahead in terms of the profile of those dividend payments in future years as share prices will move ahead of changes in earnings and dividends.

Takeout #3: The 142 opportunity

Inclusive of franking credits, the ASX200 has delivered an attractive yield relative to term deposits over the long term – and especially over the past decade. Driven by underlying economic growth, the resilience and rise in share prices is also a characteristic of dividend payments through time. Furthermore, Australian corporates continue to favour higher payout ratios due to Australia’s policy of attaching tax credits to dividends for the tax paid on profits earned by companies.

This payment of tax credits is what Redpoint refers to as the ‘142 uplift’. Every dollar of fully franked dividend carries with it a 42 cent tax credit that zero tax rate retiree investors can fully reclaim at year end. For every dollar of fully franked dividends a retiree at a zero tax rate earns from a company, they’re actually getting $1.42 worth of value. For every dollar of interest income that same retiree earns from a bank deposit, they get a dollar of interest income. On the flip side, when the investor reclaims their term deposit, they receive their capital in full. The same cannot be said about equities; price volatility means an investor may or may not get back the total amount invested.

Example: If the total return of the Index is 8%, made up from 4% cash dividend and 4% growth, the associated tax credit will be ~1.7% (fully franked) or 1.3% (75% franked). Changing the split to 6% cash dividend and 2% growth still gives the same pre-tax total return of 8% but the tax credit is now 2.5% (fully franked). This 1.2% p.a. higher than holding a passive investment.

This is an additional benefit for retired income investors and opens up a range of investment strategies that combine capture of these valuable dividends and credits along with an active stock selection approach aimed at ensuring that an investor has a diversified exposure to a broad range of companies listed on the ASX.

When one truly appreciates the power of the 142 uplift it becomes obvious that an investment approach that can capture a higher level of franked income while delivering the same overall total return as the ASX200 provides a materially better outcome when compared to investors who simply hold the index or low dividend portfolios and sell assets to fund their annual income needs.

Takeout #4: Headwinds, tailwinds and opportunities ahead

While there has been some volatility in dividends over the last few years, Australian equity income investors are currently well positioned. The largest potential headwind is whether interest rates will be increased to the point where they actually cause a recession.

In such a scenario, investors need to carefully consider how they position their portfolios to ensure they capture both a sufficient dividend yield, which will likely be better than the interest rates offered on term deposits, and also capture reasonable long-term capital growth.

Sentiment and behavioural biases also make share prices fluctuate. Sentiment can cause share prices to be depressed because of expectations or extrapolation of interest rates moving higher and inflation getting out of control. Such sentiment driven price falls can create an opportunity to buy income cheaply because share prices are depressed while the underlying fundamentals for companies remain less volatile.

Importantly, the profitability of companies and industry sectors are cyclical, which in turn drives cyclicality in dividend payments; yesterday’s dividend payers are likely to be different to tomorrow’s dividend payers. After all, last year’s dividend windfall for iron ore miners is expected to fall back in the years ahead as commodity prices cycle with supply and demand.  This is where a forward looking approach is important both in terms of identifying the next winners while also having a view on which future dividends may be cut.

One of the major opportunities is demographics, both in Australia and other developed nations, where almost one third of the retirement savings pool will move into the retirement phase over the next 10 years. In Australia, that’s almost a trillion dollars that will move from accumulation to retirement.

Redpoint believes there will be a greater focus on companies paying dividends – and focusing on maintaining a consistent dividend – because that will become attractive to a far greater proportion of investors in the marketplace.

This may in fact become a tailwind; some of these stocks that can maintain consistency of dividend payments may trade at a slight premium because those characteristics will be increasingly in demand.

Many people in retirement have traditionally sought low risk investments, namely cash and term deposits. For example, Australia’s SMSF sector has nearly $150 billion sitting in cash and term deposits, 16.5 percent of the $892 billion in SMSF assets, at 31 March 2022^[2].

In the current environment, and potentially for the foreseeable future, the low-risk or no-risk investment has in fact become the low return or no-return investment. When inflation is factored in, cash does not provide a positive return and it becomes challenging to maintain the purchasing power of retirement capital over the longer-term.

For retirees to achieve a growing income stream, as well as ensure that their capital stays in line with purchasing power and inflation, equities are an obvious solution.

Takeout #5: Equity investments are an attractive source of income

Long term purchasing power

Consumer purchasing power is linked to inflation which in turn is driven by the long term average growth in the economy. The earnings – and therefore dividends – of ASX200 companies are determined by these same drivers. History shows that over the long term, dividends grow through time in line with earnings.

In an inflationary environment, equities are considered to provide some hedge against inflation. Most companies can increase the cost of their goods and services to maintain profitability and their ability to pay dividends.

While cash and fixed income investment have a place in a comprehensive retirement income plan, they will be insufficient on their own. Interest rates paid by banks and other similar institutions are determined by the prevailing monetary settings of the central bank. These settings are determined by a range of factors and have drifted lower over the past decade as central banks sought to induce growth and inflation to avoid a Japan like deflationary spiral.

Ultimately cash deposits are capital guaranteed and that guarantee comes at a cost…no capital upside. Over the long term, the total return of the Australian equity market is approximately evenly split between dividend yield and price return.

Dividend yields at 4%+ remain attractive versus cash like investments. The long term uptick in price (even by just a few percentage points) is an important component to maintaining overall purchasing power in retirement, something cash-like investments cannot deliver.

Dividends exhibit consistency

Companies will set payout ratios with flexibility to pay out a higher or lower percentage of their profits each year, which allows them to smooth out the inevitable fluctuations in their profits and cashflows each year. An examination of the volatility of dividend payments by Redpoint found that when averaged across a three year period, dividend payments have been reasonably consistent.

Figure three illustrates that dividend payments have exhibited stability when averaged over a three year period. Lower share prices today point to the ability for investors to purchase a dividend stream for the same price as December 2020 or September 2019.

Capturing a consistent dividend yield from equities cannot be a set and forget endeavour. Building a portfolio from last year’s best-yielding stocks may deliver above average dividend income, but won’t necessarily meet other objectives, such as being able to keep up with inflation and the cost of living for retirees over their entire retirement period.  This is because a singular focus on high dividend yield can also be a proxy for companies with low growth potential or corporate stress which may lead to cuts in dividend payments in future.  A sole focus on that one concept of yield can also result in a very concentrated portfolio that’s invested in a narrow range of sectors, such as financials and the mining sector at present and this may result in a poorly diversified portfolio which is at risk if those specific sectors perform poorly in future.

Earning income by owning a share of the profits paid as dividends by Australia’s leading companies remains a critical part of a long-term retirement income plan.  Taking an active approach which seeks to earn an above average dividend yield coupled with stock selection insights can deliver investors with better long-term results versus owning a passive portfolio and supplementing income needs by selling assets over time.  While share prices are volatile in the short term, dividend payments are less so and can provide additional benefits via franking credits for retiree investors.

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[1] https://www.commbank.com.au/banking/term-deposits.html – 24-33 month rate
[2] https://data.gov.au/data/dataset/self-managed-superannuation-funds

Important information: The information included in this article is provided for informational purposes only. The information contained in this article reflects, as of the date of publication, the current opinion of Redpoint Investment Management (Redpoint) and is subject to change without notice. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Redpoint, GSFM Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.

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Mr Page and Mr Parks join from Australian Retirement Trust (ART, formerly QSuper) and both have over a decade’s experience developing and implementing investment strategies that target improved environmental and social outcomes.

At ART, Mr Page was responsible for managing the Socially Responsible investment option which grew from $320 million to $960 million under his management. Prior to joining ART, Mr Page was the head of new business at Regnan, an impact investment manager which is now part of the Pendal Group. He has also worked at UBS, where he developed and implemented its global ESG strategy in Zurich, Switzerland.

Mr Parks was most recently a sustainable investment strategist at ART, responsible for developing and implementing the fund’s approach to managing climate change risks and opportunities, including aligning the fund to net-zero and the ambitions of the Paris Accord. Prior to joining ART, Mr Parks was an ESG analyst at Credit Suisse and at Regnan. He has also held ESG analyst roles with MSCI and ANZ Bank.

Max Cappetta, CEO at Redpoint, said the appointment of Mr Page and Mr Parks provides further depth to Redpoint’s responsible and impact investing capability.

“With the addition of Hunter and Chris to the team, Redpoint is now well placed to expand on its existing responsible and impact investment capabilities, blending the deep global knowledge that they bring with our active quantitative approach. This expertise will enable us to provide our clients with strategies that have a positive financial, environmental and societal impact while also remaining aligned to our proven investment disciplines.

“Hunter joins the team with a breadth of experience as a sustainable and impact investment specialist spanning Australia, the United Kingdom, the United States and Switzerland in wealth management, asset management, and superannuation roles.

“Chris joins us with deep sustainable investment experience as a climate change and impact investment specialist across investment banking, asset management and superannuation.

“Together, we look forward to providing investors with a distinct investment strategy to leverage the opportunities presenting from sustainable development and the global transition to a less carbon intensive economy, while also meeting our client’s investment performance objectives,” he said.

Damien McIntyre, CEO of GSFM, said the appointments add further expertise to what is already a highly capable investment team.

“We support Redpoint’s decision to expand its investment capabilities to include impact specific strategies because we believe such strategies matter. The aspiration of achieving a higher standards of governance and stewardship for investor capital is in everyone’s best interests.

“The appetite for impact investing is set to increase over the next decade, and with investment professionals of the calibre of Chris and Hunter joining the firm, Redpoint will have a strong, well-resourced team to develop and manage these strategies to meet the needs of investors.”

Mr Page studied impact investment at Oxford Saïd Business School and has a Graduate Diploma in Applied Finance and Investment (FINSIA), along with a Bachelor of Economics from the University of Sydney.

Mr Parks has a master’s degree in Environmental Management from the University of New South Wales, a Bachelor of Business Administration from Macquarie University, and a Certificate in Applied Finance from Kaplan. He is also pursuing further studies in climate change from the Australian National University.

They joined Redpoint Investment Management on 19 April 2022

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Stephen Miller

The first half of 2022 will continue to be an uncertain time for markets as the full impact of the Omicron variant makes its mark on the Australian economy – but there are still opportunities for investors, with certain sectors and thematics set to shine, according to GSFM and its fund manager partners Munro Partners, Tribeca Investment Partners and Redpoint investment Management.

Munro Investment Partners chief investment officer, Nick Griffin, says he remains positive on global equity markets in 2022, although he concedes the outlook is murkier than usual.

“Market outlook predictions have become increasingly problematic in the last few years, and 2022 looks to be no exception. However, despite the many unknowns, there are a couple of trends that are now reasonably clear.

“One is that growth will slow.  Alas, the world can only re-open once and many businesses will begin the cycle by being assessed against the strong re-opening led numbers they produced in 2021. At the same time, government stimulus will begin to run off, most notably in the US.

“Regardless of economic outlook, our focus remains on identifying sustainable growth trends and the resulting winning stocks. And the trends of decarbonisation, eCommerce or cloud computing don’t abate because the macro landscape evolves.

“The key areas where we see positive tailwinds for 2022 include climate – where the race to decarbonise the planet is likely to accelerate as corporates and countries alike start to implement plans to reach carbon net zero by 2050 – and high performance computing – as every major corporate seeks to harness the power of its own data and implements AI across their organisations. This will unleash a torrent of silicon demand that should lead to exponential growth for the key players in the semiconductor industry,” Mr Griffin says.

Meanwhile GSFM investment strategist, Stephen Miller, says bond yields have started the year under pressure and that seems likely to continue.

“Notwithstanding the recent increase in yields, bond markets remain at close to historically low levels. More tellingly, the gap between the 10-year bond yield and annual core CPI inflation was close to 4 per cent in December, the highest gap since February 1975.

“Persistence in inflation and a rapid scaling back of central bank purchases could send bond yields significantly higher as bond markets price in that eventuality.

“At this point, inflation continues to surprise on the upside with December readings in the US, Europe, the UK and Canada all exceeding expectations and all close to multi-decade highs. This is not a comforting scenario for global equity markets. However, it must be acknowledged that a more benign scenario has central banks getting on top of inflation quickly and bond markets retaining confidence in central banks’ ability to do so.

“The same challenges exist locally even if their magnitude may be slightly less. Of course, the Australian economy is different from other developed economies not least in its exposure to China, but not sufficiently so that the same laws of supply and demand and their effect on prices do not apply here,” Mr Miller says.

Pointing to the local share market, Tribeca Investment Partners portfolio manager, David Aylward, says that uncertainty will be the order of the day – at least for the first quarter of 2022.

“Omicron may be a game changer, possibly washing the COVID-19 recession that Australia thought it had avoided up on our shores.

“With previous COVID-19 variants, the government response was to implement a lock-down where everyone stayed home, and when lock-downs were lifted they later came out and spent money. And the government’s fiscal stimulus programs ensured there was money to spend.

“From an economic point of view this was a net positive. But it is different this time. With Omicron people either don’t want to go out, or they can’t go out because they are isolating – and this time there is no government stimulus to support their spending in the economy.

“This Omicron impact will be an important narrative in the upcoming Australian reporting season. It won’t necessarily show up in the numbers as yet, but it will be interesting to hear company management remarks on how they have been trading recently, and how their supply chains have been impacted.

“But even with this uncertainty that there will always be opportunity in markets, on the long and on the short side. One such area of opportunity comes from the energy transition.

“The energy transition is going to be hugely inflationary. When you combine that with the likely stimulus program coming out of China over the next six months, we could be locking in a supercycle round two for commodities. This will have significant ramifications for markets.

“A lot of stocks in the mid cap sector will be exposed to benefit from that. And it will be quite a positive for small caps as well.

“Mid and small sized Australian companies can do well in 2022 but commodity-based stocks will need to do a lot of the heavy lifting. A rebound in services can contribute as we move past Omicron but non-earners and consumer finance type stocks will likely find inflation and higher interest rates tough going,” Mr Aylward says.

Redpoint Investment Management chief investment officer, Max Cappetta, says that while the upcoming reporting season is likely to provide a strong overall dividend harvest, investors need to ensure they look beyond high yielding names and look ahead to where dividends will be growing most in the future.

“We are expecting approximately 130 dividend announcements across the ASX200 in the months of February and March 2022 and it will be a mixed bag. It is important to look across the entire market – and capture income across all sectors and yields – because there will always be winners and losers within each of these groups.

“The mining sector was responsible for carrying the ASX200 to a record aggregate dividend payment year in 2021 and remains well placed to provide solid cashflows again in 2022 supported by more accommodative policy in China.  However, there are many opportunities in the metals of tomorrow such as copper and lithium and Australia has some great companies with great assets already in production across the globe.

“Those companies benefitting from a domestic consumer unable to travel and move more freely, such as JB HIFI, consumer group GUD and auto retailer Eagers are also likely to deliver strong dividend yields in February. 

“We also see the potential for revenue and profit growth in 2022 in the lower yielding healthcare sector from diagnostics services firms such as Healius and Sonic.

“We expect modest dividend growth from banks and financials even though dividends in this sector remain below pre-COVID highs.  Investor should also note that the dividends of major banks are offset through the year with Commonwealth Bank being first up in mid-February.  This provides a valuable insight into trading conditions for the sector,”  Mr Cappetta says.

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Max Cappetta

More than 60 listed Australian companies will be holding an Annual General Meeting over the next six weeks. Operational updates provided by company management at these events is arguably more important today than it has been over the past few years.

Investors should looking for a number of factors when a company provides guidance. COVID uncertainty has materially changed the information dynamic of company guidance in 2020, which initially saw most companies withdrawing all earnings guidance as we went head first into a global pandemic lockdown. AGM season in Q4 2020 was equally quiet with a skew to the positive (more upgrades vs downgrades) because companies had been conservative and setting low or now forward expectations. Additionally, fiscal and monetary stimulus measures were dialled up and vaccine development was pointing to a more positive 2021.

One of the key issues that investors will be looking for over the coming weeks is “cost pressures” and lower than expected revenue growth. Domino’s, for example, was sold off more than 15 per cent after announcing cost pressures were increasing across their supply chain.

Investors should keep an eye out for the following company AGMs:

• Kogan (25 November): Can Kogan maintain its revenue growth (up 100 per cent since 2018) given an end to lockdowns and consumers looking to devote spending back to services? Can they maintain margins in the near term and are they seeing cost pressures which will squeeze their margins? These are critical questions when the stock is trading at 30x 2022 earnings having fallen over 50 per cent thus far in 2021
• Seek (17 November): Seek’s revenues have halved since 2019 and 2022 estimates are still 30 per cent below that level. Has Seek taken this opportunity to build a leaner and more efficient business which can deliver similar profit levels on smaller revenue? This is probably a 2023 story but we need to see what cost guidance they provide and whether there is scope for a positive revenue surprise. Seek’s share price is already factoring in a fast reversal and trades at 50 per cent higher than its pre-COVID high, which means the upside is already priced in and there could be a fall back if recovery is slower than expected.
• Wisetech (19 November): The company surprised the market with a bumper 2021 result back in August and reacted by pushing the share price up more than 75 per cent. Things obviously get more difficult now and the company needs to continue to show it can earn increasing margins for the cargo management software for every $ increase in revenue. Comments from Wisetech regarding cargo movements and volumes will also provide insights into how global supply chains are evolving as we head into 2022
• Mineral Resources (18 November): we remain confident that Australia’s iron industry remains well placed to be a supplier of choice for the global steel industry, and that steel demand will remain robust and supported by ongoing infrastructure spending, such as the US infrastructure bill passed last week. That said, the prices for many miners has weakened as the iron ore price has fallen given lower demand from Chinese steel mills. The uncertainty for these miners is not if demand will ramp up – but when. Investors also need to consider the actual delivered price for each miner’s ore as this will be different to the benchmark price.

With cost pressures likely to remain a key issues for companies and investors, companies set to benefit include:

• Ampol to benefit from an increased fuel refining margin even as consumers lament higher fuel cost
• Banks – as net interest margin earners – will welcome a rise in interest rates while home loan owners will not. The main risk for the banks is unemployment and the impact of a falling property prices. The current robust jobs market provides comfort that wage increases can offset some of the higher loan costs. Even though the RBA has said rates will remain on hold until 2023, they have conceded they will no longer artificially hold down the three-year government bond yield.

There is plenty to focus on with AGMs over the coming weeks, particularly the guidance and cost pressures in determining who will enter 2022 with momentum and where the risks and opportunities lie for investors.

By Max Cappetta, Chief Executive

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The tide is turning: Shareholders have been rewarded with a record level of dividend payments from the 2020-21 financial year.

The most recent reporting season affirmed how the global COVID-19 pandemic impacted businesses and sectors in different ways and as expected, announcements of dividend payments for the next 12 months will likely be back in line, or ahead of, those that paid pre-COVID. Max Cappetta, CEO of GSFM investment partner Redpoint Investment Management discusses the outlook for, and sources of, dividends in the coming year.

Shareholders have been rewarded with a record level of dividend payments, more than $35 billion, from the 2020-21 financial year. It’s a stark turnaround from a year ago, when dividend payments were slashed as many companies chose to stockpile their capital rather than distribute it to shareholders.

And while dividends are rapidly returning to pre-pandemic levels, the sources of these dividends are likely to be different to previous years.

Inclusive of franking credits, the ASX200 has delivered an attractive yield relative to term deposits over the long term – and especially over the past decade. Driven by underlying economic growth, the resilience and rise in share prices is also a characteristic of dividend payments through time.

Furthermore, Australian corporates continue to favour higher payout ratios due to Australia’s policy of attaching tax credits to dividends for the tax paid on profits earned by companies.

This important policy pillar supports the retirement savings system and will enable appropriately constructed equity portfolios to play their part in an effective retirement income strategy. The Australian Government’s 2021 Intergenerational Report is forecasting that over 40% of retirees will be self-funded by 2060, and less than 25% will be drawing a full government pension (versus 50% today).

A growing need for retirement income

There’s approximately $750 billion in today’s retirement super pool that, over the next decade, will move into a retirement phase. This is a huge amount of capital that will transition from an accumulation approach to a strategy more suited to retirement. In retirement, people need income, however, they also want their capital to grow over their retirement period. This helps shield them from longevity risk, or the risk of outliving their retirement savings.

Many people in retirement have sought low risk investments, namely cash and term deposits. For example, Australia’s SMSF sector has nearly $150 billion sitting in cash and term deposits, 18 percent of the $822 billion in SMSF assets, at 30 June 2021 (source: ATO).

In the current environment, and potentially for the foreseeable future, the low-risk or no-risk investment has in fact become the low return or no-return investment. When inflation is factored in, cash does not provide a positive return and it becomes challenging to maintain the purchasing power of retirement capital over the longer-term.

For retirees to achieve a growing income stream, as well as ensure that their capital stays in line with purchasing power and inflation, equities are an obvious solution.

Over the long term, the total return delivered by Australian equities can be divided into an income return of approximately 40 percent from dividends, and the remaining 60 percent from capital growth.

High capital growth is important for the accumulation phase where earnings are taxable; most investors prefer to actually have their assets growing. However, in the retirement phase, most investors prefer income to capital growth. In an ideal world, retirees would prefer up to 75 percent of the total return from equities delivered as income.

Retirees still need growth to ensure their capital maintains its purchasing power throughout 25-30 years of retirement. So, how can you turn the total return components of the Australian equity market, in many ways, upside down?

The response from many investors would be to focus on those companies paying the highest dividends relative to their price. However, that can be a dangerous approach because that can result in an investment in companies that are potentially stressed with low share prices are today, relative to previous higher dividends. High dividends may also indicate that a company is not growing, and so they choose to pass off their cashflow to investors as dividend income.

Therefore, investing for equity income and a reasonable total return that can keep up with inflation over the long-term is a multiple objective strategy. While investors should pay regard to previous dividends, it is also important to look at a company’s future earnings and profitability. This provides an indication of where the dividend income opportunities may be in future periods.

Dividends returned in 2021

Australia’s mining sector was set to be the star of the corporate reporting season in Australia and did not disappoint. Record profits were expected from companies involved in iron ore mining, thanks to record high prices. Companies such as Fortescue, Rio Tinto and Mineral Resources delivered record dividends.

Government financial support during the pandemic and ensuing lockdowns ensured that retail spending remained robust. Retailers such as JB Hi-Fi and Kogan have been beneficiaries and rewarded investors with growing dividends. Supermarkets have also benefited from the ‘stay-at-home’ thematic, with Coles and Metcash paying a growing dividend stream over the past two years.  More recently Woolworth’s shareholders were rewarded with an increased final dividend and the opportunity to participate in a $2.2b share buyback.

Healthcare has also delivered on dividends, with plasma giant CSL, protective-wear specialists, Ansell, and equipment manufacturer Fisher and Paykel Health all growing their dividends (albeit this growth has not translated to share price growth for CSL, which currently trades at 10 percent below its pre-COVID highs).

The IT sector has also been a standout winner in the past year, driven by low interest rates and the perceived stability in their revenues, irrespective of whether workers are in the office or at home. Global logistics software specialists Wisetech more than doubled its dividend payments in 2021 versus 2020. Similarly, global security specialist Codan has grown dividends by 50 percent in 2021 versus 2019 levels. Both companies pay fully franked dividends, albeit they are a low yield.

This highlights that income-focused investors need to ensure their income generation also provides some exposure to earnings and dividend growth, and not simply focus on high yield alone. Wisetech has almost doubled in price recently after a strong earnings result, while Codan, having fallen back from recent highs, now trades at $13, more than 50 percent above its pre-COVID high of $8.50.

For the banking sector, Australia’s banking regulator, the Australian Prudential Regulation Authority, dropped restrictions that banks limit dividends to 50% of profits in mid-December. This enabled an increased dividend from all four of Australia’s largest banks in the first half of this year.

CBA further increased its dividend in August after being more cautious in February, with the remaining three seeing economic conditions improve in early 2021 before paying increased dividends in May. The rollout of product innovations and divestments in the sector could be a catalyst for earnings growth moving forward.

On the other side of the ledger, COVID-19 has been devastating for industries such as tourism and travel. After promising signs through the start of 2021, the subsequent lockdowns meant ongoing tough operating conditions. Now that lockdowns are lifting, circumstances will improve for tourism and travel businesses. Investors also need to be aware of the potential for mergers and acquisitions as trading conditions improve.  One such example is the current takeover offer for Sydney Airport.

Just like driving: look forward, not back

Being distracted by a high historic yield can be detrimental to investment outcomes. High yields can often hide low growth, business stress or a failure to properly reinvest to support future growth.

Research indicates that a focus on historical yield has consistently underperformed the ASX200, and by taking a forward-looking approach to dividend yields, opportunities can be found. A track record of consistent or growing dividend payments is a sign of reliability and can be an indication that investing in the company will provide a reliable income stream in the future.

Don’t focus only on high yields

A company that is producing dividends or that has a high dividend yield is not always a good investment. There have been cases where a company’s management has used dividend payments to make up for a lack of growth and placate frustrated shareholders. To avoid ‘dividend traps’, it’s important to understand the company’s dividend strategy.

In some cases, market movements can artificially inflate the dividend yield. A good example of this was the GFC, when the dividend yields of many stocks were driven higher because of falling share prices. Although these dividend yields may have looked good, many of those companies experienced a steep fall in profits, which then impacted the company’s ability to pay any dividends at all.

The market goes through phases where dividends and companies that pay dividends are in demand, and other periods when they are not. The past 15 months are a brutal reminder of investor appetite for growth and risk versus cashflow and dividends.

Some income-focused strategies commence with defining an investible universe based on higher dividend yielding stocks. Some strategies start with a specific income style and then seek to identify the highest yielding stocks within that sub-group. This can be rewarding at times when dividend-paying companies are in greater demand but can be harmful to overall returns at other times.

Being constrained to invest in just a subset of the market can also lead to less consistent dividend capture if particular sectors of the market are impacted by a change in business conditions while others are not. This is where risk management and a diversity of stock selection views can deliver an investment edge versus a singular focus on high yield alone.

Different companies pay dividends at different times during the year. There is an opportunity for a dynamic approach to trade across these different periods to capture an overall above-average income yield while retaining exposure to higher growth stocks. Of course, investors need to abide by holding period rules to ensure they not only capture the cash dividend but also any tax credits attached.

Capturing a consistent dividend yield from equities cannot be a set and forget endeavour. Building a portfolio from last year’s best-yielding stocks has delivered above average dividend income but has consistently underperformed the index overall.

Looking ahead to 2022

Figure three indicates the number of distinct events where company management has either initially provided a profit expectation and then have subsequently affirmed, downgraded or upgraded their guidance. It shows that 2020 was an interesting year: earnings guidance was not affirmed as many companies simply withdrew their earnings guidance, and there were many more earnings downgrades due to the unknowns of the COVID-19 pandemic.

So far in calendar 2021, there have been few downgrades as companies are reinitiating with conservative expectations, but we still have the upcoming AGM season where there may be some downgrades due to the impacts of extended lockdowns in NSW and Victoria.

Investors need to be wary of downgrades or a lack of guidance from companies trading at high valuations as no news – or bad news – could lead to a share price de-rating. For example, companies such as JB HiFi, Bunnings and Officeworks owner Wesfarmers, and Carsales Ltd may guide more conservatively for 2022 if COVID reopening and a shift in consumer spending back towards services and leisure is expected to slow their revenue growth next year.

Investors also need to watch the number of companies affirming any guidance they presented at their 30 June results announcement. For example, Redpoint will be keeping an eye on those companies with a 31 December balance date, including energy and mining giants Woodside, Oil Search, Santos and Rio Tinto, Engineering group Cimic and car dealer Eagers Automotive.

The other key area to monitor will be commentary regarding costs as an indication of whether inflationary pressures are expected to be transient or ongoing.

From a dividend perspective, in the year ahead, further rises in profitability and dividend payments are expected from:

• mining companies, including BHP, Rio Tinto and Woodside
• James Hardie, driven by ongoing growth in the US market
• offshore toll road owner Atlas Arteria, which owns toll roads in the US and Europe (France and Germany) and will benefit from increasing mobility over the Christmas period and into 2022
• healthcare group Healius, which is well placed with its network of pathology labs and diagnostic testing facilities and is expected to see increased activity into 2022.

The goal for most income-seeking equity investors should be to earn a consistent and above average yield on their capital and including an appreciation of the calendar and industry profit cycles can assist with this goal. While the last year has been one of the most challenging in history, it has also highlighted the opportunities for a more dynamic perspective into how investors should seek to capture income from equities.

This is the approach adopted by the Redpoint Australian Equity Income Fund, a diversified Australian equity portfolio that aims to capture an above average income yield for investors who are in retirement or at a zero tax rate. The focus is on delivering a growing income over time, as well as being able to keep up with inflation and the cost of living for retirees over their entire retirement period.

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Important information: The information included in this article is provided for informational purposes only. The information contained in this article reflects, as of the date of publication, the current opinion of Redpoint Investment Management (Redpoint) and is subject to change without notice. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Redpoint, GSFM Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article. GRES has produced a Target Market Determination (TMD) in relation to the Redpoint Australian Equity Income Fund. The TMD sets out the class of persons who comprise the target market for the Redpoint Australian Equity Income Fund and is available at www.gsfm.com.au

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Max Cappetta

The Separately Managed Account (SMA) Model Portfolio of boutique asset manager, Redpoint Investment Management, has been added to investment and superannuation platform, HUB24.

According to Redpoint chief executive and senior portfolio manager, Max Cappetta, the availability of Redpoint’s SMA on HUB24 provides advisers and their clients with access to Redpoint’s investment expertise together with HUB24’s managed portfolio capability.

“Investors are becoming more sophisticated and with a preference for direct ownership of their share portfolios. This has many benefits including that investors’ have full tax transparency, and holding the shares directly means any dividend payments flow directly into the investor’s account as soon as the company elects to pay a dividend.

“We purpose-built this strategy for an adviser group some six years ago, and encouragingly, it now has far broader support from investors Australia-wide.

“The SMA structure delivers all the benefits of direct share ownership for investors and their advisers coupled with Redpoint’s investment expertise for building and managing effective portfolio solutions for investors,” he said.

The Redpoint SMA Model Portfolio has delivered a gross income yield of 6.04 per cent per annum since its inception in 2015 by holding a diversified portfolio of approximately 40 better quality companies. Redpoint’s approach to stock selection is focused on ESG sustainability metrics and also incorporates the manager’s views on quality, financial strength and growth.

“Our stock selection is purposefully long-term and this has meant the SMA Model Portfolio has low turnover, which directly supports the tax effective capture of income and wealth accumulation,” he said.

Mr Cappetta said investor adoption of SMA model portfolios has grown in recent years, with the range of strategies available via SMA expanding beyond domestic equities to now include global equities, fixed income and other direct assets.

“The broadening of the range of available strategies is allowing investors to use an SMA structure for larger proportions of their portfolios and, combined with the tax benefits and share ownership, this trend is set to continue for some time,” said Cappetta.

The Redpoint SMA Model Portfolio currently has over $230 million in Funds Under Management, and is also available via the MLC Navigator and Macquarie Wrap investment platforms.

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Damien McIntyre

Boutique equities asset manager Redpoint Investment Management has launched an Australian equity income fund aimed at yield-seeking investors such as self-funded retirees, other low-income tax rate payers as well as the not-for-profit sector.

The Redpoint Australian Equity Income Fund will sit alongside Redpoint’s Tax Effective Australian Share Fund and Australian Industrials SMA strategy, offering investors a life cycle of equity strategies for tax effective saving from wealth accumulation through to retirement. The new fund aims to capture a dividend yield above that of the S&P/ ASX 200 index with a total return greater than the index over the long-term (three to five years).

Redpoint IM chief executive, Max Cappetta, said the ability to deploy the firm’s established quantitative investment capabilities to build a dividend focused strategy comes as Australia’s aging population seeks viable investment solutions to provide adequate income in retirement.

“Investing in Australian equities remains a core exposure for domestic investors driven, in part, through the receipt of tax credits associated with dividend income. Our quantitative approach combines multiple perspectives, including income capture, stock selection, ESG sustainability and tax awareness within one risk managed portfolio.

“Our research and product development work over the past year has shown that capturing income from dividends is best achieved when also taking account of a range of other stock selection insights. This naturally includes the insights we derive from our proprietary sustainability framework,” he said.

Fund manager GSFM acquired a 49 per cent equity stake in Redpoint IM in 2019, with Redpoint’s investment team continuing to control 51 per cent of the business.

GSFM chief executive, Damien McIntyre, said the new fund will provide institutional and retail investors with the opportunity to access proven investment expertise, with a strong focus on capturing income from a diversified portfolio of listed Australian companies.

“Redpoint’s disciplined active approach and the way in which they combine multiple investment drivers within one portfolio will prove attractive for those Australian investors seeking a greater level of income from their equity investments. It’s an opportune time to be bringing this type of product to market,” said Mr McIntyre.

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Nick Griffin

The COVID-19 pandemic recovery remains non-linear across developed and emerging economies leading to a patchy outlook for bond and equity markets, but pockets of opportunity remain, according to GSFM and its fund manager partners Payden & Rygel, Munro Investment Partners and Redpoint Investment Management.

Payden & Rygel director, Eric Souders, says the next phase in the COVID-19 economic recovery will be in developing parts of the world.

“We expect this phase to begin during the latter part of this year, with encouraging data points already occurring and a continued belief that we will continue to see vaccine diplomacy expand to smaller, poorer countries.

“From a bond market perspective some attractive opportunity remains in securitised credit. In addition, an opportunity also lies within emerging market debt – which we are preparing for now – as we believe the market will begin to price in this opportunity before year-end.

“Notably, we have identified high-quality parts of the below investment grade sovereign universe as an opportunity. Valuations here, relative to corporate credit, are at 10 year highs and fundamental tailwinds are already in place, such as rising commodity prices, a benign US dollar, and a strong recovery in China.

“With all that said, fundamental research is paramount and security selection critical given broad market valuations are not cheap and volatility remains very subdued. In this environment absolute and unconstrained bond strategies – which eschew benchmarks and focus on returns over time – will become more prominent in the marketplace,” Mr Souders says.

Munro Investment Partners chief investment officer, Nick Griffin, says the emerging global economic recovery is allowing for him to invest in a broader set of investment ideas.

He is seeing opportunity in a number of focused areas of interest, including digital enterprise, the emerging consumer, semiconductors, climate and innovative health, and says the pace of the global economic recovery will provide greater scope for the team to scout out investment opportunities.

“Last year markets were very bifurcated, but now that we are poised for economic recovery as vaccine rollouts are implemented around the world, there are a number of compelling opportunities that we can start looking at again.

“For instance, emerging consumer stocks – such as aerospace and luxury goods – are areas that have been in the fund in the past, and the recovery has provided the opportunity for us to invest in them again. Airbus and Italian luxury good manufacturer Moncler have returned to the fund in 2021.

“Other areas – like semiconductors – are ones that we have liked for a long time. They did well during lockdown and they will also do well in an economic recovery. Semiconductor investments have been very good for our portfolio over the long term, both through the recent recovery and also through lockdown. Nvidia and Dutch lithography equipment manufacturer ASML are key investments here.

“Another important focus is climate change. Climate is hugely leveraged to stimulus spending, and it will also do well during an economic recovery. As companies refurbish or rebuild or spend for the future they will obviously do this in a greener way, and there are a number opportunities in this area. HVAC equipment manufacturer Trane Technologies and wind turbine OEM Vestas are good example here.”

Mr Griffin says the team doesn’t focus on trying to target particular countries or economies when it invests, but rather looks for companies within its areas of focus with good prospects.

“Earnings growth will drive stock prices and provided you don’t pay too much for them it will all work out in the long term,” he says.

Locally, GSFM investment strategist Stephen Miller says investors can expect the maintenance of the historically high accommodatory tack from the Reserve Bank of Australia (RBA) to continue for the foreseeable future.

“The RBA is happy in the current circumstance to lag the normalisation of policy rates, particularly compared to other commodity-intensive developed economies such as Canada, Norway and New Zealand where rate increases are foreshadowed within a year. The point of difference between the RBA and the others is underscored by the RBA’s expectation that that the condition for any increase in the policy rate “will not be met before 2024.”

“As part of the quest to generate tight labour markets and attendant wage and price inflation, the RBA remains motivated to avoid an unwelcome upward movement in the Australian dollar (AUD). Any move up in the AUD could well frustrate the task of getting unemployment down and wage growth and inflation up.

“As the RBA has achieved its stated objective in pursuing yield curve control and quantitative easing of keeping the AUD low, it is unlikely to risk the unwinding of those achievements by prematurely foreshadowing a more significant retreat from the currently historically high levels of monetary accommodation.

“That will likely remain the case until there is some clarity around the US Federal Reserve’s roadmap to tapering.

“In emphasising outcomes, the RBA may feel that while inflationary pressures in the US are clear – and there is debate about its persistence – those pressures are less visible in Australia.

“The RBA also appears largely unconcerned by market expectations of inflation rebounding perhaps reflecting the fact that current market-based expectations of inflation are toward the bottom end of the RBA’s 2-3 per cent target range,” Mr Miller said.

Redpoint Investment Management CEO and lead portfolio manager for Australian equities, Max Cappetta, says local economic conditions have made it challenging for those investing for income.

“However it is clear that dividends are returning for equity investors, after the largest contraction in payments in living history.

“The growth in dividends from resources is of particular note, as a result of all-time highs in the price of iron ore. This is being driven by strong global demand as well as production issues in Brazil tightening supply. Our key picks here are Fortescue, Rio Tinto and Mineral Resources.

“Bank dividends too, are on the way back. Government and RBA support has meant that earnings and debt provisions have not been as bad as expected, but new lockdowns are cause for concern. We do not expect them to return to pre-COVID levels until calendar 2023.

“There are also a range of dividend winners over the past year that are growing dividends or looking at returning capital to investors via buybacks. Key examples are in retail – such as JB Hi-Fi which grew dividends in 2020, Metcash which recently announced an off-market buyback and Woolworths which has indicated that capital management may also be on its radar,” he says.

With dividends returning, Mr Cappetta adds it is important for investors to look beyond simply choosing high yield stocks.

“There is a cyclicality to dividends over the calendar year, and it is important to align stock selection with dividend capture,” he says.

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Redpoint is a boutique global equities manager specialising in quantitative strategies across Australian equities, global equities, global infrastructure and global property.

Mr Ying will be responsible for trade execution, and will assist with portfolio management and research, covering Australian and global equities, FX and futures markets.

He joins Redpoint from MLC Asset Management, where he was a senior investment analyst, responsible for monitoring and rebalancing multi-asset portfolios. Prior to MLC, he was a portfolio management analyst at Dimensional Fund Advisors Australia, where he was involved in company and portfolio analysis, cash flows management, and various research, development and reporting projects.

He has a Bachelor of Commerce (Liberal Studies) (Honours) from the University of Sydney, and a Master of Quantitative Finance from the University of Technology, Sydney.  

Redpoint chief executive, Max Cappetta, said Mr Ying brings extensive experience in company analysis, portfolio cashflow and trade management to the role.

“Nick is an experienced and skilled quantitative investment professional with a demonstrated history of success in the investment management industry. He is a welcome addition, and the broader Redpoint team will benefit from his insight and expertise.”

Redpoint has also appointed Tao Chen as quant developer, reporting to head of technology, Andrew McGregor.

Mr Chen will be responsible for Redpoint’s data capture, processing and maintenance, as well as database development, analytics and data engineering.

He joins from PwC Australia where he was a senior software engineer focused on designing, developing and implementing data-driven ways to automate auditing and accounting processes. Prior to PwC, he was a software developer at Services Australia, where he was involved in data and document migration projects. He also took a lead role in a range of IT projects such as robotic development, web application development, virtual assistant development and machine learning capability development.

Mr Chen holds a Bachelor of Science (Physics) (Honours) from Swinburne University of Technology.

Mr Cappetta welcomed Mr Chen’s appointment to the team, pointing to the depth of his knowledge in software engineering.

“Tao’s work with PwC and Services Australia is solid, and his experience and expertise mean he is well placed to take on this role with Redpoint.

“Nick and Tao both join Redpoint at an important time as we see growth potential due to increased investor interest across a range of our strategies including global listed infrastructure, our enhanced responsible investment solutions plus our retail focused Tax Effective Australian Share Fund and Australian Industrials SMA strategy.

“Redpoint is also planning further product development in coming months, in response to market demand, and the expanded investment team will assist as the business grows its footprint in the market,” Mr Cappetta said.

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Emma Herd

Quantitative equities investment boutique Redpoint Investment Management has become a member of the Investor Group on Climate Change (IGCC), a collaboration of Australian and New Zealand investors focusing on the impact climate change has on the value of investments.

Redpoint IM chief executive officer, Max Cappetta, said membership of IGCC is a logical step for the firm. The Sydney-based asset manager is already a signatory to the United Nations Principles for Responsible Investment (UN PRI) and has a research framework compatible with the reporting framework of the Global Reporting Initiative (GRI).

“We are continuously developing our reporting to highlight changing climate risks for clients, including monitoring how companies are managing their environmental practices, and the way they are addressing emissions reduction, resource utilisation and product innovation, for example.

“Our membership to IGCC comes at a critical time globally for climate change policy, and for climate action within investing. Our investment team has always considered sustainability as an important investment driver and climate change is core to this perspective. The investing world is transitioning from policy development to implementation and we want to play our role in supporting investors to build better portfolios,” he said.

IGCC chief executive officer, Emma Herd, said: “We are delighted that Redpoint IM has joined as a member of IGCC and look forward to the practical insights and experience the organisation will bring to our agenda.

“Climate change poses systemic risks to financial markets and creates significant challenges for investors. At the same time the inevitable transition to net zero emissions is driving enormous new investment opportunities. Collaboration across the industry is critical to ensuring all investors are best equipped to minimise these risks, capitalise on these opportunities and have their voice heard in climate policy debates.”

IGCC represents institutional investors who combined have total funds under management of over $2 trillion. The organisation aims to encourage government policies and investment practices that address the risks and opportunities of climate change, for the ultimate benefit of superannuants and unit holders.

Membership of the IGCC is open to investors operating in Australia and New Zealand including superannuation funds, insurance companies, fund managers and other financial services providers, such as asset consultants, brokers and investment industry associations.

Redpoint IM specialises in quantitative strategies across Australian equities, global equities, global infrastructure and global property. Across its investment strategies and funds, the manager applies a proprietary sustainability framework underpinned by environmental, social and governance (ESG) as a measure of sustainability.

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