Reap What You Sow: An analysis of income and price returns of the BetaShares Australian Dividend Harvester Fund (ASX Code: HVST) | BetaShares

Reap What You Sow: An analysis of income and price returns of the BetaShares Australian Dividend Harvester Fund (ASX Code: HVST)

BY David Bassanese | 16 August 2016
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The BetaShares Australian Dividend Harvester Fund (managed fund) (HVST) has proven popular with investors since its inception in October 2014, particularly in light of elevated equity market volatility and the search for yield in today’s low interest rate environment.  This note demonstrates that since inception HVST has been able to generate high income returns that have helped it generate positive gross total returns that have been greater and less volatile than that of the S&P/ASX 50 Index.

The BetaShares Australian Dividend Harvester Strategy

The BetaShares Australian Dividend Harvester Fund (managed fund) (ASX Code: HVST) is specifically designed to meet the challenges of investors seeking attractive income in a low interest rate environment, but who desire to limit the usual downside risks associated with investing in the share market.  These challenges are more fully detailed in our Whitepaper Strategies for Managing Investment Risk in Retirement.

To meet these challenges, the Fund employs a two-pronged strategy.  First, the Fund utilises a rotation strategy whereby it aims to hold fourteen or more shares which will be rebalanced approximately every two months. The rebalancing (or ‘harvesting’) process aims to include in the portfolio the shares that are expected, within the next rebalance period, to provide the highest gross yield outcomes.  Secondly, the Fund employs a risk management strategy which aims to manage the Fund’s overall volatility and cushion downside market risk.

More details of the Fund’s overall strategy is provided here.

HVST’s Price vs. Income Returns  

Share ownership typically produces two sources of return: an income return provided by dividend payments, together with a price return provided by appreciation in the prices of the shares (often caused by earnings growth). Within a given year, moreover, the share price of individual stocks may tend to rise or “run-up” just ahead of a declared dividend (the value of the dividend is effectively priced into the stocks), after which prices may fall back somewhat after shares go “ex-dividend.”

To the extent HVST holds securities for a rolling two month period, it is exposed to the capital gains produced by the the securities’ price appreciation during this period. The Fund’s rotation strategy, moreover, also exposes more dividend opportunities each year than with a buy-and-hold approach. Indeed, this is the basis on which HVST aims to provide a strong income stream comprising dividends and franking credits, that is at least double the yield of the broad Australian share market on an annual basis.

As the Fund’s rotation strategy means it is often holding stocks about to go “ex-dividend”, the Fund can be exposed to some capital losses when these shares are eventually sold after the dividend has been paid. In a purely efficient market, the total returns from the Fund’s rotation strategy would equal that of a “buy and hold strategy”, the only difference being more of the total return in the Fund’s case would be produced by income rather than capital gain.

That said, several research studies suggest that the market in this regard is not always efficient, as a carefully constructed rotation strategy – especially one that fully encompasses the value of franking credits –  has been able to generate higher total gross returns than a buy and hold strategy.  This may at least partly reflect market inefficiency with regard to the value of franking credits,  perhaps because these are of less benefit to foreign investors and not often a key focus of local fund managers which still tend to be assessed on their net or “pre-tax” investment performance.

In this regard, financial theory suggests that the type of rotation strategy employed by the Fund should broadly be able to match the market’s overall total returns over time (though with returns skewed to income over price returns), with some possibility of above market returns to the extent the market misprices the value of franked dividends. Of course this does not include the effect of any ‘stock specific’ risk that comes from the actual holdings of the Fund which may at times under or outperform the broad market itself.

Last, but not least, the final element of the Fund’s returns over time is that derived from the risk management strategy.  This strategy aims to reduce the Fund’s overall net market exposure in times of high market volatility so as to reduce the volatility of the Fund’s returns over time and cushion downside market risk.  At heart, this strategy aims, over market cycles, to provide most of the upside in rising markets while avoiding most of the downside in periods of decline – which as explained in the Whitepaper above, can be of particular value for investors in a capital drawdown phase.

HVST’s Performance

As seen in the chart below, the Fund’s performance since inception has been relatively good, with total gross returns (i.e allowing for franking credits) not only exceeding that of the S&P/ASX 50 Index over this period, but also exhibiting less volatility on a day-to-day basis. Notably, the Fund held up relatively well during the market’s downturn in January and early-February of this year – as well as during more recent market pullbacks in April and June.

hvsttot
Past performance is not an indicator of future performance. Gross return assumes franking credits are income (i.e. a zero-tax environment). The treatment of franking credits will vary depending on an investor’s tax situation – please consult your financial adviser for more information.

We can also split these returns into their income and price components.   As seen in the chart below, the Fund has consistently produced stronger gross income returns – as would be expected given its rotation strategy and focus on high income producing shares.  Since inception, the Fund has produced gross income annualised returns of 13.9%, compared with 6.4% for the S&P/ASX 50 Index.

hvstincome
Past performance is not an indicator of future performance. Gross return assumes franking credits are income (i.e. a zero-tax environment). The treatment of franking credits will vary depending on an investor’s tax situation – please consult your financial adviser for more information.

As seen in the chart below, this relatively strong income performance, moreover, has been only partly offset by weaker price return performance. Again, as might be expected given the risk management overlay, the Fund’s price returns under performed somewhat during the period of strong market gains in early 2015.  And as was explained in an earlier note, the Fund also experienced a bout of “stock specific” risk earlier last year when it was holding bank stocks during a particularly sharp decline in financial stocks – such a “stock specific” risk may be encountered by the Fund on occasion and which the broader risk management strategy does not attempt to counter.  That said, since late last year, the price performance of the Fund has been relatively stable and much less volatile than that of the S&P/ASX 50 Index.

hvstprice
Past performance is not an indicator of future performance.

A full income and price break-down of the Fund’s performance since inception – and over the past year – is provided in the table below, along with a measure of return volatility.  This performance is also compared to both the S&P/ASX 50 and S&P/ASX 200 Index.

Several notable features stand out:
  • In keeping with its investment objective, the Fund has produced gross income returns at least twice that of the broader market indices on an annual basis.
  • Although the Fund has experienced relatively stronger capital loss since inception, this only partly offset its strong income return, such that total gross returns exceeded that of the S&P/ASX 50 Index and were close to that of the S&P/ASX 200 Index.
  • The Fund’s capital loss over the past year was broadly in line with that of the S&P/ASX 50 Index. Note the stronger price performance of the S&P/ASX 200 Index over the past year reflects strong outperformance by small cap stocks, which do not form part of the Fund’s strategy.
  • The volatility of the Fund’s daily returns were broadly half that of both broader market indices.
hvsttable
 Past performance is not an indicator of future performance. Gross return assumes franking credits are income (i.e. a zero-tax environment). The treatment of franking credits will vary depending on an investor’s tax situation – please consult your financial adviser for more information.

What long term capital performance can be expected by HVST?

As the nature of the Fund’s rotation strategy may expose it to some capital loss from some stock holdings going “ex-dividend” over time, a natural question that arises is what long-term capital performance might be expected from the Fund?  As should be apparent from the analysis above, this is highly dependant on one’s assumptions about market efficiency and the broader market’s income and price return performance over time.

By way of example, if we assume the universe of top 50 stocks (by market capitalisation) from which the Fund selects investments is able to generate a gross income return of 5% p.a. and price returns of 5% p.a., and we further assume the Fund is able to generate a gross income return of 10% p.a., it follows that if the market were efficient (such that total gross returns from the market and the Fund were the same), the Fund would not be subject to capital decay, generating zero capital growth over time (i.e it will produce a price return under performance relative to the market of 5%). This also assumes that the risk management overlay, which can significantly effect performance over the short run, given its aim to reduce volatility over market cycles, neither detracts nor adds to performance over the long term.

All up, in a truly efficient market, one would expect the Fund to underperform from a price return perspective by broadly the degree to which it outperforms from a gross income perspective. That said, given some evidence that the market is not efficient with regard to the valuation of franked dividends, there does appear potential for the Fund to produce market-beating total gross returns over time – and with less volatility.

What’s more, to the extent an investor wants to seek a somewhat different balance of income and price returns from the Fund, there is always the option of reinvesting all of part of their income distributions.  Should they so wish, the Fund enables investors to elect to participate in the Distribution Reinvestment Plan, which automatically reinvests a level of income return – the proportion of which is at the investor’s choosing – into more units of the Fund.

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