Reading time: 4 minutes
Lower rates and more cuts on the cards
With the Reserve Bank of Australia (RBA) cutting the official cash rate to just 1.00% on 3 July 2019, savers and investors face increased challenges in deriving enough income from their investments to meet their needs. This is an ongoing issue as interest rates are forecast to remain at – or even fall below – historic lows for the foreseeable future.
Chart 1: Official Australian cash rate
Source: Reserve Bank of Australia, July 2019.
The yield problem – generating sufficient income in a low rate environment
Faced with lower interest rates, we expect investors and their advisers to continue to develop investment strategies that help deliver the required income with the appropriate level of risk.
One noteworthy option is the BetaShares Legg Mason Real Income Fund (managed fund) (ASX: RINC). Launched in February 2018, the Fund aims to provide a pre-tax income yield above that of the S&P/ASX 200 Index, and had a forecast franked portfolio yield of 5.4% as at 31 July 20191. RINC is based on the strategy of the unlisted Legg Mason Martin Currie Real Income Fund, which was the recent winner of the 2019 Money Management/Lonsec Retirement and Income Category Award2.
RINC holds a portfolio of listed companies that own ‘hard’ physical assets, like property, utilities and infrastructure (e.g. A-REITs, airports, toll roads, electricity and gas grids). Real Asset companies like these are an integral part of everyday life and are often monopolistic in nature. Top holdings in the Fund currently include Transurban Group, Stockland, Vicinity Centres and AGL Energy3.
Their demand profile is relatively inelastic and not pegged to the business cycle, hence these companies have more predictable free cash flow and dividends.
The typically long-term nature of their cash flows (underpinned by long-term contracts and favourable regulatory structures) looks to provide a level of protection during market downturns, as well as upside growth potential. This means Real Asset companies typically have a low beta versus the broader equity market and have scope to provide lower-volatility, regular and more dependable income streams.
Due to their strong market positions, and the growing demand driven by population growth, Real Asset companies generally have the ability to raise prices, in some cases above inflation, irrespective of the business cycle. In other words, Real Assets are generally poised to protect future income from inflation. This makes them relatively defensive equity investments.
Pricing for Real Assets is also inversely influenced by the prevailing bond yield. As interest rates and bond yields fall, the share prices of Real Asset companies tend to perform well as it implies a lower discount rate for future income streams.
Few investment funds in Australia offer exposure to this attractive combination of Real Assets.
The real advantage – attractive returns with relatively low risk
The comparable unlisted fund, the Legg Mason Martin Currie Real Income Fund, since inception in December 2010 has consistently grown its income stream and, as shown in the chart below, has a record of delivering defensive low-beta characteristics.
The chart shows the comparable unlisted fund’s risk and return trade-off, compared to the S&P/ASX 300 Australian Real Estate Investment Trust (A-REIT) Index and the broader sharemarket as measured by the S&P/ASX 200 Index.
The total returns (capital plus income) net of fees for the comparable unlisted fund, measured over rolling 5-year periods have been strong compared to the performance of narrow A-REITs and the broader sharemarket. These returns have been delivered with less risk (as measured by standard deviation).
Chart 2: The Real advantage
The sweet spot of sustainable income and risk-adjusted returns
5 year rolling risk and return (% p.a.) to 30 June 2019
Source: Martin Currie Australia; as of 30 June 2019. As the BetaShares Legg Mason Real Income Fund (managed fund) ASX: RINC commenced in February 2018, the performance of the unlisted Legg Mason Martin Currie Real Income Fund is shown to show how a comparable fund managed by Martin Currie using the same strategy has performed over longer periods. The inception date of the unlisted fund is December 2010. Historic performance of the unlisted fund is not a reliable indicator of the performance of RINC. Data calculated for the unlisted Legg Mason Martin Currie Real Income Fund in A$ net of management fee. Rolling 5-year periods annualised.
This strategy is not constrained by a benchmark, however for comparison purposes the S&P/ASX 200 Accumulation Index and the S&P/ASX A-REIT 300 Accumulation Index are used. Past performance is not a guide to future returns.
RINC targets attractive risk-adjusted returns and can be considered for inclusion in a broad income solution. It is uniquely positioned and aims to provide a high, growing and sustainable income stream.
1As at 31 July 2019. Yield forecast is calculated using the weighted average of broker consensus forecasts for each portfolio holding and research conducted by Legg Mason Australia, and excludes the Fund’s fees and costs. Franking credit benefit assumes a zero tax rate. It is not to be interpreted as the offset achieved by unitholders during this period. Actual yield may differ due to various factors, including changes in the prices of the underlying securities and the number of units on issue. Neither the yield forecast, nor past performance is a guarantee of future results. Not all investors will be able to benefit from the full value of franking credits.
2 Lonsec/Money Management Fund Manager of the Year – Retirement and Income – Winner 2019.
3The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
Past performance is not an indicator of future performance. This article has been prepared by Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849 AFSL 240827) (Legg Mason Australia). BetaShares Capital Ltd (ABN 78 139 566 868 AFSL 341181) (BetaShares) is the issuer and responsible entity of the BetaShares Legg Mason Real Income Fund (managed fund) (ARSN 621 862 619) (Fund). BetaShares has appointed Legg Mason Australia as investment manager for the Fund. Legg Mason Australia is part of the Global Legg Mason Inc. group. Martin Currie Australia, a division within Legg Mason Australia, provides the investment management services for the Fund. Before making an investment decision you should read the Product Disclosure Statement (PDS) for the Fund carefully and consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting BetaShares on 1300 487 577 or Legg Mason Australia on 1800 679 541 or at www.betashares.com.au or www.leggmason.com.au. This information does not take into account the investment objectives, financial objectives or particular needs of any particular person. Neither BetaShares, Legg Mason Australia, nor any of their related parties guarantees any performance or the return of capital invested. Past performance is not necessarily indicative of future performance. Investments are subject to risks, including, but not limited to, possible delays in payments and loss of income or capital invested.