After nearly a decade of incredibly easy monetary policy, the global interest rate cycle is turning. The US Federal Reserve has started to increase official interest rates and unwind quantitative easing and in Australia, although official interest rates are on hold, the next move is more likely to be up rather than down. So where does this leave equity income strategies that have benefited so much from historically low interest rates?
Structural themes matter most
Right now, we are in the early stages of the interest rate cycle but it’s not really policy tightening. It’s actually policy normalisation. It’s all about taking the US Federal Funds rate from zero back up to a more “normal” level relative to history, now that the US economy has recovered. And it’s important to remember that it’s cyclical – it should only continue for a relatively short period of time. The more significant long-term driver of demand for equity income is a structural change in demographics that isn’t going to disappear anytime soon. The dominant “baby boomer” generation is entering retirement and seeking to generate sufficient income on which to live. So income is becoming an increasingly important component of investment returns. Meeting the income requirements of these investors in a relatively low interest rate world is a project spanning decades and it will inevitably require continued diversification of yield portfolios with a strong focus on equities.
The demographic imperative of income growth
Australians are also living longer and this trend is forecast to continue. As the chart below shows, the life expectancy of Australian men and women is now
over 90 years and has increased by around 20 years since 1960. So the probability that we outlive our savings is growing – this is known as longevity risk. Investors seeking income should therefore focus on solutions that can provide a sustainable, growing and real (after inflation) income stream, while also protecting their capital base. In our view, this requires a change in investor behaviour and the need to challenge some traditional investment approaches.
Australian life expectancy (at birth)
Source: Australian Institute of Health and Welfare, Australian Treasury Intergenerational Report, ABS, March 2018
Active ETF equity income solutions
A successful equity income fund needs to focus on two objectives. Firstly, it should target companies whose dividends are both sustainable in difficult economic conditions and are expected to increase in value over time. Secondly, through active management of company selection, the goal is to identify companies that offer the potential for long-term capital growth, thus increasing the value of units for the investor. BetaShares Legg Mason has two new equity income Active ETFs designed to meet these specific needs.
The BetaShares Legg Mason Equity Income Fund (managed fund)(ASX: EINC) invests in Australian companies that have high quality business models and solid track records of
paying dividends through the business cycle. It aims to provide investors with the benefits of high, growing income and franking credits combined with the potential for less risk than the overall share market.
The BetaShares Legg Mason Real Income Fund (managed fund)(ASX: RINC) invests in ASX-listed securities that hold real or ‘hard’ physical assets including listed property, utilities and infrastructure (A-REITs, toll roads, ports, airports, electricity and gas grids). Very few investment funds in Australia offer this combination of real assets.
Both EINC and RINC are rated highly by research house Lonsec. EINC is forecast to provide a dividend yield of 7.1% (grossed up for franking credits) over the next 12 months on a forward-looking basis, whilst the corresponding yield forecast for the RINC is 6.0%.1
EINC and RINC are managed by wholly owned Legg Mason investment affiliate, Martin Currie Australia. Martin Currie is a global active equity specialist, crafting high-conviction portfolios, which aim to deliver attractive and consistent risk-adjusted returns for clients.
The Funds can be bought and sold like any share using the ASX code: EINC or RINC.
1As at 31 July 2018. The yield forecast for the next 12 months is calculated using the weighted average of broker consensus forecasts of each portfolio holding and research conducted by Legg Mason Asset Management Australia
Limited, is gross of franking credits and excludes Active ETFs fees and costs. Actual fund yield may differ due to various factors, including changes in the number of units on issue, and not all investors will be able to receive the full value of franking credits. Neither the yield forecast nor past performance is a guarantee of future results.