5 smart yield picks for your portfolio

The usual suspects for dividend yield are resembling a line-up of losers. Consider the banks. ANZ, Commonwealth Bank (CBA), NAB and Westpac (WBC) have prospective yields of 6-7% before franking, using consensus estimates. That’s attractive, but banking risks are rising, as property prices fall and extra regulation weighs on profitability.

Another go-to income stock, Telstra Corporation (TLS), should yield 5.5% in FY19 before franking. Its challenges are mounting as it loses market share in mobile phones. Infrastructure stocks, sought by income investors for defensive yield, are mostly fully valued. Then there’s Australian Real Estate Investment Trusts (AREITs). It’s hard to see AREITs and other interest rate-sensitive sectors outperforming in a global environment of rising rates.

Yield bulls could even make a case to buy BHP Billiton, Rio Tinto or Fortescue Metals Group given their prospective yields of 5% to 7%. The resource sector, however, is no place for conservative income investors, given dividends depend on volatile commodity prices.

Adding to the challenge is Labor’s misguided proposal to stop franking credit refunds. With opinion polls suggesting a Labor victory at the next Federal election, yield investors must consider how Labor’s plan would affect demand for fully franked shares.

Taken together, these factors suggest the risk of buying individual companies for dividend yield, particularly in rate-sensitive sectors, is rising.

My fear is not that dividends will disappoint; the latest profit season showed OK growth in dividends. Rather, that investors who buy stocks for income could suffer capital loss that more than wipes out the yield. Telstra’s performance this year reinforces that risk.
 

Different approach needed

I prefer a fund approach that spreads risks and benefits from a professional manager, rather than buying stocks directly. Why get 6% from an individual stock when you can get 6% from a fund that owns 100 stocks?

Investors who fill their portfolios with bank stocks, Telstra, Woolworth and a few AREITs for yield underestimate the concentration risk of having so much capital tied up in a few sectors. There are better ways to get yield and more attractive risk-adjusted returns on offer.

To be clear, this week’s column is focused on conservative income investors. By that I mean people nearing, or in, retirement, who want reliable, steady income from their investments; people who want to minimise the volatility that comes with owning a small portfolio of stocks.

I considered a range of unlisted income funds, listed investment companies and exchange-traded funds that have interesting income strategies, for this column. Also included are a few recently listed or quoted funds that readers may not be familiar with.

Here are five funds to consider.
 

1. Plato Income Maximiser (PL8)

Based on the investment strategy of the Plato Australian Shares Income Fund, PL8 is designed for self-managed superannuation fund (SMSF) and pension-phase investors. It was the market’s first Listed Investment Company (LIC) to pay monthly dividends.

PL8 suits investors who want lower-risk exposure to high-yielding Australian shares. The fund’s historical yield at August 2018 was about 5.5%, according to ASX data.

As a LIC, Plato can trade at a discount or premium to NTA, which adds another element of risk and opportunity (the discount was 4% in August).

2. BetaShares Legg Mason Real Income Fund (RINC)

Quoted on the ASX in February 2018, RINC is an active exchange-traded fund (ETF). Unlike passive ETFs that aim to mirror an index return, RINC actively manages its underlying portfolio to enhance returns above its benchmark index.

RINC mostly invests in REITs, infrastructure and utility securities, making it an option for income investors who want diversified exposure to yield sectors. Its largest stock exposures are AGL Energy, APA Group, AusNet Services and other defensive stocks.

RINC has started well, returning almost 5% over three months (after fees), and 8.4% since inception. The comparable unlisted fund on which RINC is based, managed by Martin Currie Australia (a Legg Mason affiliate) has delivered strong long-term performance.

RINC’s forecast franked portfolio yield is 6%. A management fee of 85 basis points is higher than most ETFs (due to its active management) and less than many active unlisted funds.
 

3. Macquarie Income Opportunities Fund (MIM01)

The well-regarded fund invests in a range of global investment-grade credit securities (mostly floating and fixed-rate corporate bonds and asset-backed securities) and cash. As such, it provides diversified exposure to bonds – something that is hard for Australian retail investors to achieve directly.

MIM01 has returned 5.5% annually since inception in 2003 and has consistently outperformed its benchmark index. Returns have been less in the past few years in a low interest-rate environment but the long-term performance is solid.

It is not just about the headline return. The fund’s focus is capital preservation (the first rule of investing) and minimising risk through a diversified portfolio. MIM01 was recently made available through ASX’s mFund service.
 

4. Vanguard Australian High Shares Yield ETF (VHY)

The Vanguard ETF is one of several “smart-beta” ETFs designed to enhance yield through index-construction strategies. Yield ETFs have had mixed results and their methodology can differ widely, with some including more mid-caps and small-caps in their index construction and methodology, to boost returns (while increasing risk).

As with any ETF, always assess the index methodology, underlying portfolio, managers and fees before investing in yield-focused ETFs.

VHY is designed to provide low-cost exposure to Australian stocks that have higher forecast dividends. The ETF has returned almost 9% annually since inception in May 2011 and the management fee is low at 25 basis points.

Again, this strategy is as much about risk reduction as it is return. VHY is forecast to yield 7.9% (after franking) from a portfolio of 54 stocks. That return stacks up against many popular yield stocks on the ASX but has less risk than investing in a single stock for its dividend.
 

5. BetaShares Active Australian Hybrids Fund (HBRD)

Another actively managed ETF to join the ASX, HBRD is an interesting option for income investors. The underlying portfolio, managed by Coolabah Capital Investments, provides exposure to a portfolio of hybrid securities, bonds and cash.

HBRD is the market’s first active ETF in hybrids, an ASX-listed security that combines elements of debt and equity instruments and has potential for higher returns and risk.

Hybrids from well-known companies, banks and insurers can provide attractive income. But they also provide debt-like returns with equity-like risks, meaning some are too complex and risky for conservative investors. Hybrids can be volatile and have liquidity risk.

Investing in a portfolio of hybrids that spreads risks and has a well-performed manager at the wheel makes a lot more sense for conservative investors than buying hybrids directly. This is no market for inexperienced or risk-averse investors.

HBRD has returned almost 3% (after fees) since inception in July 2018. The portfolio’s estimated gross yield, from 40 hybrids held, is 5.26%.

Just over 80% of the portfolio is held in bank hybrids. Investors who buy bank equities directly for yield might find a diversified portfolio of bank hybrids offers a slightly lower yield, but with far less risk than holding a few bank stocks directly.