Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 97

Searching for yield to pay the bills

The RBA cut the target cash rate to 2.25% in an effort to boost consumer and business confidence and arrest growth in the unemployment rate. Whilst this move was positive for equity investors and saw the ASX hit multi year highs, it was a negative for savers, especially retirees living off the income generated by their term deposits. ANZ cut its one year TD rate to 2.6% and with the inflation rate for 2014 running at 2.5%, savers are receiving close to a zero percent real return (after inflation) on their term deposits.

The result of this rate cut will be that investors who rely on the income produced by their portfolio will be forced to move up into riskier investments just to maintain their standard of living.

Millionaires eating baked beans on toast!

Earlier this week I met with a well-respected fund manager who raised an interesting point. He said that historically a retiree would feel secure in funding their retirement if they had, through a lifetime of careful saving and judicious investing, amassed $1 million dollars in their superannuation account. Indeed in 2008 this investor would have received a risk free income of over $80,000 from investing their portfolio in term deposits, enough to cover a comfortable existence without risking their nest egg.

Currently that same strategy would deliver just $26,000 for the retiree with $1 million dollars, effectively the ‘poverty line’ in 2014 of $25,896 calculated by the Melbourne Institute for a couple with no dependants that own their own home. I found this observation interesting as in the funds management world, the vast majority of our focus is on growing the capital, rather than thinking about the ongoing income that this capital is often required to deliver.


Source: RBA

The Australian banks have been significant beneficiaries of falling term deposit rates, not only through the declining cost of capital, but also due to the increase in retail appetite for bank hybrids. This retail interest has allowed the banks to build their capital bases in the lead up to Basel III, without issuing equity that would dilute earnings (and compromise bank CEO’s earnings per share growth targets). In the last three years Australian banks have raised $20.4 billion in hybrids and subordinated debt from mostly retail investors at attractive margins for the banks. These issues have been sold to yield-hungry investors primarily based on the headline rate and the name recognition of the big bank issuing them, often with little regard to the actual terms and conditions of the issue.

For example in January, ANZ ‘s Capital Notes 3 raised over $750 million at a margin of +3.6% or a current coupon rate of 5.85%. Not only was this margin too low given the ten-year term of the issue, but also in a ‘worst case scenario’ investors are no better off than ordinary shareholders, despite owning these ‘preference shares’. ANZPF holders will receive a pre-tax distribution of 5.85%, whereas ANZ common stock holders are looking at a grossed up dividend of 8.3% (which can grow) for facing similar risks.

A more extreme variation on this theme of investors not getting compensated for the risks they are taking is the continuing success of finance companies raising money from investors. Companies like Fincorp and Westpoint offered investors interest rates of 9.25% and 12% respectively, which sounded very attractive and almost double the prevailing interest rate. Unfortunately these funds were used to make mezzanine finance loans to property developers, so investors really should have been demanding double this interest rate!

Look behind the yield on high-yielding equities

Over the last few years among the most common questions that I have received from investors are around the theme of ‘juicing up’ distributions by picking higher yielding stocks. Typically this comes in the form of a list of the highest yielding ASX200 that the investor has obtained from a website and questions as to why these stocks are not in the portfolio.


Source: Bloomberg, Philo Capital

Basic high yield strategies tend to underperform and have done so on the ASX over the past 20 years. We see that this is due to the characteristics of companies that tend to pay high dividends:

a) mature companies in decline
b) companies in industries with low growth
c) companies where there is material risk that the dividend will be maintained.

Looking at the above table of the large listed companies ranked by dividend yield, a number of them have all three dividend risk characteristics. Arrium’s steel and Metcash’s supermarket businesses could be characterised as being in decline and the market has concerns about both companies’ ability to pay dividends in the future. Duet’s energy utility business is low growth and faces upcoming regulatory risk, which could impact distributions especially in light of the very high payout ratio (Duet pays out more in distributions that it currently receives in profit). The future of Cabcharge’s payments business is opaque with their monopoly on taxicab payments processing being undermined by technological developments such as Uber.

Whilst investors may be able to temporarily generate a high yield from owning a basket of these stocks, there is not a great chance that these companies can maintain their dividends, let alone grow them ahead of inflation.

 

Hugh Dive is Head of Listed Securities at Philo Capital Advisers. This article is for general investment education purposes. It does not take into account individual objectives, financial situation or needs.

 

  •   19 February 2015
  • 4
  •      
  •   

RELATED ARTICLES

Are major bank hybrids really yielding 7%?

On interest rates and credit, do you feel the need for speed?

Finding the best income-yielding assets

banner

Most viewed in recent weeks

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Why I dislike dividend stocks

If you need income then buying dividend stocks makes perfect sense. But if you don’t then it makes little sense because it’s likely to limit building real wealth. Here’s what you should do instead.

Latest Updates

Investment strategies

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Retirement

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

The ASX is full of broken blue chips

Investing in the ASX 20 or 200 requires vigilance. Blue chips aren’t immune to failure, and the old belief that you can simply hold them forever is outdated. 

Shares

Buying Guzman y Gomez, and not just for the burritos

Adding high-quality compounders at attractive valuations is difficult in an efficient market. However, during the volatile FY25 reporting season, an opportunity arose to increase a position in Mexican fast-food chain GYG.

Investment strategies

Factor investing and how to use ETFs to your advantage

Factor-based ETFs are bridging the gap between active and passive investing, giving investors low-cost access to proven drivers of long-term returns such as quality, value, momentum and dividend yield. 

Strategy

Engineers vs lawyers: the US-China divide that will shape this century

In Breakneck, Dan Wang contrasts China’s “engineering state” with America’s “lawyerly society,” showing how these mindsets drive innovation, dysfunction, and reshape global power amid rising rivalry. 

Retirement

18 rules for ageing well

The rules to age successfully include, 'the unexamined life lasts longer', 'change no more than one-eighth of your life at a time', 'nobody is thinking about you', and 'pursue virtue but don’t sweat it'.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.