No franking worries! Generating income without relying on franking credits

The proposed removal of franking credit rebates that is part of the ALP’s election policy has been an ongoing point of discussion over the last 12 months. Irrespective of debate around the upcoming election or the form any rule changes may ultimately take, a central issue for many investors is how to maintain a level of income without dramatically overhauling their investment strategy or making drastic asset allocation shifts, should the ALP’s policy become law.

An investor seeking to manage the impact of these potential changes might consider reassessing the underlying investments in their asset mix and their sources of income to ensure they are maximising the income from the whole of their portfolio.

Here we look at the role three income-generating ETFs, in asset classes outside of the Australian equities allocation, might play.

BetaShares Global Income Leaders ETF – ASX: INCM

The dividend yield on the broad global MSCI World Index has traditionally been notably lower than the yield on the broad Australian sharemarket – currently just 2.5% on a 12-month forward basis.Likewise, many of Australia’s largest actively managed global funds available on the ASX have portfolios heavily weighted towards growth companies, particularly large technology names, which tend not to pay large dividends.

The BetaShares Global Income Leaders ETF (ASX code: INCM) was specifically designed to provide Australian investors with a means of enhancing the dividend yield from their broad global equities allocation. The fund invests in 100 high yielding companies outside of Australia with a track record of paying regular dividends. All companies are subjected to a range of dividend sustainability screens, including dividend persistency, payout ratio and profitability. These companies tend to be mature, and have also shown defensive characteristics during market pullbacks – the index which INCM aims to track has a track record of lower drawdowns during periods of market falls compared to the MSCI World Index.

The index that INCM aims to track currently yields 5.47% p.a. gross of withholding tax (WHT) or 4.70% per annum net of WHT (as at 31 March 2019)2.

BetaShares Legg Mason Real Income Fund (managed fund) – ASX: RINC

Unlike dividends from company shares, distributions from A-REITs don’t have franking credits attached. That’s because, as trust structures, income isn’t taxed at the level of the A-REIT before it is paid out to investors. Likewise, the structure of many Australian listed infrastructure and utility securities means that a portion of their income is not taxed at the investment vehicle level, and consequently the franked proportion of their distributions tends to be lower than that paid by many other listed companies.

The BetaShares Legg Mason Real Income Fund (ASX code: RINC) invests in an actively managed portfolio of listed Australian real assets – predominantly A-REITs but also Infrastructure and Utilities. Importantly for most income investors, the fund has a forecast net yield of 5.45% with a gross yield of 5.66%3, meaning franking accounts for only ~0.21% of income returns.

Low franking levels aside, investing in these types of assets is generally viewed as a way to mitigate the erosion of purchasing power by inflation. Many of the underlying assets of these companies and trusts benefit directly from population growth, and due to their strong market positions, often have the ability to raise prices, in some cases above inflation, irrespective of the business cycle. Real asset companies tend to have more predictable free cash flow and dividends.

BetaShares Australian Investment Grade Corporate Bond ETF – ASX: CRED

Australian investment grade fixed rate bonds are an important component of the asset allocation mix by virtue of the relatively stable income they provide, and due to their portfolio diversification properties.

The largest bond funds quoted on the ASX hold most of their underlying portfolios in government and semi-government bonds. Investment grade corporate bonds have been described as the ‘middle ground’ on the risk-return spectrum – above risk-free but still a good deal lower than equities. The addition of investment grade corporate bonds via the BetaShares Australian Investment Grade Corporate Bond ETF – ASX: CRED can allow investors to generate higher returns than those from investing solely in government and semi-government bonds. As of 26 April 2019, CRED had a yield to maturity of 3.21% p.a. compared to the Australian Commonwealth Government 10-year bond yield of 1.78% p.a 4. Importantly, because they are investment grade, the bonds in CRED’s portfolio have a relatively lower risk of default compared with lower quality bonds.

1. Source: Bloomberg.
2. Source: Bloomberg. 12 month trailing dividend yield for underlying Index, not ETF. Yield will vary and may be lower at the time of investment.
3. As at 26 April 2019. The 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. 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.
4. Source: Bloomberg. Yield will vary and may be lower at time of investment.


This article mentions the following funds

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