Diversify, but don’t set and forget
Plato manages the portfolio of its Listed Investment Company, the Plato Income Maximiser (ASX: PL8), with the aim of paying monthly dividends and delivering investors above-market levels of income annually. It may come as a surprise that the majority of our top-yielding holdings aren’t what many consider to be Australia’s traditional dividend-paying stocks.
(Editor’s note: Do not read the following ideas as stock recommendations. Do further research on your own or talk to a financial adviser before acting on themes in this article).
Consider the miners. Three of the top six dividend payers in Australia today are mining companies – Fortescue Metals Group (ASX: FMG), Rio Tinto (ASX: RIO), and BHP (ASX: BHP). For many investors, this would have been inconceivable just a few years ago.
We’ve held a positive view on the resources sector for several years, comfortable with the global supply/demand equation for iron ore. Over the past three years, FMG, RIO, and BHP alone have delivered our portfolio 3.4% per annum gross income.
The question we now face is how long will the mining-stock dividend boom continue?
We still maintain a positive outlook on mining-stock dividends for the foreseeable future. Our experience in active equity management has taught us things always take longer to play out than markets would indicate.
Samarco (the massive Brazilian Iron Ore miner owned by BHP and Vale) is only just coming back to full production five years after a devastating dam disaster. We often see miners forecast swift production resumption after major issues, but the reality is it usually takes longer. The Covid situation in Brazil is another impediment.
Even when this Brazilian supply comes back on, steel production is on the rise with historical levels of infrastructure stimulus leaving the supply-and-demand fundamentals intact. Should iron-ore prices come off $100-$150 per tonne from the current highs, Fortescue, Rio Tinto, and BHP will still be very profitable businesses.
Mining stocks go through cycles, and this fact shouldn’t be ignored. It’s why a “set and forget” approach isn’t optimal for dividend investing. We like miners for the short-medium term, but our view is likely to evolve as conditions change.
Retailer dividends
The same applies to retailers – again, not a traditional area for dividends in the eyes of income investors. However, it’s a sector that has produced exceptional income in recent times for investors who have actively added the right names to their portfolios.
In the consumer discretionary space, in particular, leading retailers, including JB Hi-Fi (ASX: JBH), Super Retail (ASX: SUL), and Harvey Norman Holdings (ASX: HVN), have been thriving and delivering income far superior to most other asset classes.
These consumer discretionary businesses (and others) experienced a Covid sugar-hit as consumers stocked up on products needed for working from home and increased domestic tourism, and we expect this to continue until borders are opened.
As active managers, we must consider if this will continue into the short-medium term.
It remains to be seen when full-scale international travel will resume. Australians love to travel and spend a lot of money abroad. A large chunk of that money is likely to continue flowing into domestic discretionary spending. There was evidence of this recently.
Bank dividends
When it comes to the big-four banks, they’ve traditionally been a major focus for income investors but in 2020 the outlook appeared dire as dividends were slashed across the board among the financials.
There has, however, been a remarkable turnaround, for three reasons. First, APRA took off all restrictions on bank and financial institution dividends in late 2020. Second, bad debts have proven much lower than expected. Finally, banks are seeing good loan growth fuelled by low interest rates.
In May, we saw half-year results from Westpac (ASX: WBC), ANZ (ASX: ANZ), and National Australia Bank (ASX: NAB).
Across the board, there has been a significant write-back of provisions and strong increases in cash earnings, resulting from improving economic conditions.
Outside of the big four, dividend strength is also evident. Bendigo and Adelaide Bank’s (ASX: BEN) half-year result earlier this year came in at almost 30% above expectations. Macquarie Group’s (ASX: MQG) FY21 net profit, revealed in May, was up 10% on FY20.
Although bank dividends aren’t fully back to pre-Covid levels, we believe the outlook is positive for the sector and think financials are once again an important element of a diverse equity income portfolio.
Individual dividend investors who set and forget can see their income plunge when the typical dividend stocks go through tough patches – such as the banks during the royal commission or the peak of the Covid crisis.
On the flip-side, we’re able to take a dynamic approach to generate high yield, moving around the market at any point to find strong dividends and capital returns.
Dividend income to make ends meet
In our low-rate world, effective dividend investing has been a shining light for income-seeking investors. With Australia seemingly through the worst of the Covid crisis, the outlook for dividends is improving.
Looking to the rest of 2021 and into 2022, we think there’s a positive outlook for dividends, particularly from ASX iron-ore miners, select consumer discretionary, and the banks.
Diversification, active management, and tax-effective investing can help fire up the dividend machine and ensure investors, who rely on their capital for income, don’t miss out.