Whilst there still may be a long way to go, the start of the vaccine rollout in the March quarter and overall success governments have had at containing COVID-19 in Australia, has allowed investors to look beyond the current pandemic to what the longer-term future may hold. For trust and income beneficiaries the outlook is mixed.
The March quarter saw half-year company dividends bounce back strongly from a lean 2020, restoring a valuable source of income. Despite this, interest rates remain at record lows, making it nearly impossible to earn an income above inflation from government bonds or investment grade credit portfolios.
In Perpetual Private’s quarterly investment report for January to March 2021 we look at the reasons for ongoing pressure on investment income and how we are positioning our portfolios to boost income in 2021.
Dividends make a comeback
Company dividend cuts and capital raisings over the course of 2020 – together with surprising resilience in some sectors – contributed to unexpectedly strong results in the February 2021 half-year company reporting season.
The good news is, we expect companies to continue to increase their dividends this year. As a result, from banks to A-REITs, we anticipate income from the equity component of portfolios to grow substantially from the lows of 2020.
Outlook for Fixed Income
Offsetting the stronger returns from equities, we are not as optimistic for the returns generated from the Fixed Income side of the book.
The RBA held cash rates at 0.10% over the quarter, significantly impacting Fixed Income returns. The Australian 10-year bond yield rose in February and March 2021, finishing the quarter with a yield of 1.83%. The rise in bond yields reflects investor concerns that the enormous government and central bank stimulus measures across the globe may trigger a surge in inflation. Despite the rise in yields, assuming inflation of around 2%, investors are still not achieving a real return on their capital.
At the same, this yield spike led to negative capital returns for Fixed Income. The Bloomberg AusBond Composite Index lost 3.2% during the March 2021 quarter.
Total return approach
Faced with reduced returns from Fixed Income, an alternative way to think about returns is to think about them in terms of ‘Total Return’– that is, consider the total return of the asset, not just whether that return comes in the form of capital growth, interest, or dividends but that all those components make up the return. This allows for more balanced portfolio diversification with the inclusion of companies with strong growth prospects – even if they pay little dividends.
As a company’s share price grows, the dollar amount of income should grow, even if the dividend yield remains below other ‘high yield’ stocks.
Interest rates are low. How are we responding?
Official cash rates are at record lows of 0.10%. With the RBA signalling it has little intention of raising them in the next couple of years, the message is that you may need to take on more risk to generate the income you need from your portfolio.
At Perpetual Private, our goal is to help you generate the best possible return for any extra risk you take on. We have access to different types of fixed income securities, things are a bit more esoteric such as offshore markets, where we are not increasing the risk of the portfolio but seeking a bit of a premium, for example by investing in more illiquid assets.
Another area we are looking at is core real estate. A well-leased property can generate an income while also having an element of inflation protection.
We also invest in infrastructure which is more complex than core real estate as it has an operational element and a leverage element. With complexity comes extra care required, but it is possible to generate good CPI linked income from these assets.
Overall, however, in 2021 we believe the lion’s share of income will come from the equity side of your portfolio. It’s important to understand the extra risk associated with equities, and carefully balance those risks.
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Now more than ever is the time to seek quality financial advice to ensure you plan well through 2021 and beyond. Call us on 1800 631 381.