Using income ETFs for yield
- Fri 06 November 2020
Index funds can provide exposure to companies with better yield prospects.
In many ways, the FY20 reporting season was one of the most closely watched in recent memory as investors attempted to understand the true impact of the COVID-19 pandemic on company fundamentals.
Going into the end of the financial year, expectations for earnings had been slashed significantly due to the level of uncertainty that remained in the outlook for the economy.
While there was stock level volatility and divergence (as always), the reporting season for FY20 was largely better than expected, though FY21 earnings expectations were downgraded [1]; the ASX300 returned 3.05% for the month of August [1].
Although results were better than expected at the aggregate level, many companies did not give earnings guidance for FY21 due to the uncertainty that still looms over the next 12 months in the economy.
Companies might provide trading updates during their Annual General Meetings in the fourth quarter of 2020, but it is difficult to know whether additional clarity will be available by then.
There were some notable themes at the sector level. The consumer discretionary sector was a prominent space for earnings upgrades as the “work from home” theme drove strong increases in sales. JB Hi-Fi (ASX:JBH) and Harvey Norman (ASX:HVN) were beneficiaries of this trend, outperforming the market by 9.5% and 15.8% respectively through August1.
While bank results were mostly in line with expectations, FY21 earnings for the sector was downgraded on the back of net interest margin pressures, as well as uncertainty for the economy once the fiscal stimulus has ended or is tapered significantly.
Resources companies remain resilient and reported earnings upgrades in aggregate. Iron ore miners remain were well bid as commodity-market dynamics remained favourable.
What happened to dividend expectations?
Due to the level of uncertainty that remains for the coming 12 months and the hesitation from companies to give guidance, it is not surprising that investors did not see much in terms of news flow around dividends relative to expectations.
At the end of July, the Australian Prudential Regulation Authority (APRA) eased restrictions around paying dividends for banks, however payout ratios for Authorised Deposit-Taking Institutions (ADIs) will be maintained below 50% for this year.
While this is a small positive, the outlook for bank dividends remains significantly below what investors have come to expect.
ANZ (ASX:ANZ), Commonwealth Bank (ASX:CBA), and the National Australia Bank (ASX:NAB) announced dividends, but Westpac (ASX:WBC) confirmed that an interim dividend will not be paid.
In this reporting season, approximately 35% of companies in the ASX200 have deferred, cancelled, suspended, or declared no final dividend [2].
The outlook for dividends at the aggregate market level remains subdued and shrouded in uncertainty; that is, not dissimilar to the environment before the reporting season.
In saying that, however, it appears that the outlook for dividends has potentially seen a bottom – at least for now – as the chart below suggests.
Source: Bloomberg
The expected dividend yield for the Australian sharemarket, which has historically been viewed as a high-dividend-yield market, is now around 3% [1]. This is significantly lower than the 20-year average dividend yield of 4.3% [1].
Income investing using ETFs
If you’re looking for income, dividend yield-focused funds or Exchange Traded Funds (ETF) might be worth considering. ETFs have several features:
- Transparency: At any time, the underlying portfolio holdings of an ETF can be viewed online via the ETF Provider.
- Liquidity: ETFs are traded on ASX and can be bought or sold at any time throughout the trading day.
- Diversification: Investors can gain investment exposure to a range of investment strategies, geographies and asset classes through the purchase of a listed ETF. They are an effective way to diversify a portfolio in an easy and simple manner.
- Value for money: ETFs track the performance of an index or asset class. In some instances, they apply a rules-based methodology which can mean no active management fees for investors.
The ETF manager will invest funds aligned to a particular index that is designed to meet a particular objective, such as enhanced income in the case of income-focused ETFs.
Russell Investments High Dividend Australian Shares ETF (RDV) seeks to track the Russell Australia High Dividend Index, which comprises Australian blue-chip companies with a bias towards those that have a high expected dividend yield and other characteristics such as a history of paying dividends, dividend growth and consistent earnings.
References
1 Bloomberg
2 IRESS
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