How to achieve a stable income flow in a low interest rate world

Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
(AMP Capital)
3 October 2018

 

With interest rates and yields remaining low, investors are still looking for assets that provide decent and sustainable yields. Dividends tend to grow and provide greater stability than term deposits over time, so investors should consider whether stability in the value of their investment or stability in their income flow – and a higher income flow – amidst a volatile environment is most important to them.

Most investors have been primed for rising interest rates. Yes, the US Federal Reserve has begun to hike rates, but many other countries haven’t, and yields remain low. Indeed, while the Reserve Bank is likely to keep rates on hold, there is a small downside risk that their next move could, in fact, be a rate cut. At the same time a number of factors, particularly slowing population growth, are set to constrain nominal economic growth and therefore the potential for investors to gain from capital growth.

The combination of lower investment yields and a muted outlook for capital growth suggest that the medium-term return outlook has fallen. But while investors may feel constrained, one effective thing that they can do in this environment when managing their portfolios is to focus on assets with good sustainable income.

Why yield proves its worth in a low-interest environment

  • The major reason to focus on sustainable income is that assets with sustainable income provide greater confidence around future returns.
  • Since 1900, dividends have provided more than half of the 11.8% total return from Australian shares and their contribution has been stable in contrast to the short swings in the capital value of shares.
  • Dividends are also relatively smooth over time as companies hate having to cut them because they know it annoys shareholders.
  • As baby boomers retire, investor demand for income will likely be high as their focus shifts to income generation.
  • Additionally, a high and sustainable starting point yield for an investment provides some security during volatile times. 

Where to find sustainable yield

As you can see in the chart below, yields on all Australian assets have fallen over the last few years as interest rates have fallen, however several of the alternatives still offer much higher yields than term deposits.

Australian investment yields
Past Performance is not a reliable indicator of future performance. Source: Bloomberg, REIA, JLL, AMP Capital

But there are opportunities. As you can see in the chart below, the yield on a range of Australian investments tends to be higher than global investments.

Alternative sources of yields
Source: Bloomberg, AMP Capital

 

projected medium-term returns, %pa, pre-fees and taxes
Current yield #  + growth  = return
 World equities 3.0^ 4.1 7.1
Asia ex Japan equities 2.1^ 7.0 9.1
Emerging equities 1.5^ 7.0 8.5
Australian equities 4.1 (5.3*) 3.5 7.6 (8.8*)
Unlisted commercial property 5.1 2.0 7.1
Australian REITS 4.4 2.3 6.7
Global REITS 4.1^ 2.0 6.1
Unlisted infrastructure 4.9*^ 3.2 8.1
Australian goverment bonds 2.3 0.0 2.3
Australian corporate debt 3.3 0.0 3.3
Australian cash 2.7 0.0 2.7
Diversified Growth mix* 6.2

# Current dividend yield for shares, distribution/net rental yields for property and duration matched bond yield for bonds. ^includes forward points. * With franking credits added in. Source: AMP Capital.

 

Warning: Prospective financial information must be accompanied by a warning which notes the material assumptions and clarifies that the prospective financial information:

  1. Is predictive in nature
  2. May be affected by inaccurate assumptions or by known or unknown risks and uncertainties, and
  3. May differ materially from results ultimately achieved

Two Australian asset classes, particularly, are offering attractive yields:

  1. Australian real estate investment trusts (A-REITs) are reasonable at 4.3%– following the turmoil of the global financial crisis (GFC) A-REITs have refocussed on their core business of managing buildings, collecting rents and passing it on to their investors, with lower gearing.
  2. Unlisted infrastructure offers yields of around 49%– this is underpinned by investments such as toll roads and utilities, where demand is relatively stable.

Be aware of risk

While there is a strong case for investors to focus on investments that offer decent yield, as with any investment there are risks associated with volatility in the value of the underlying investment. The alternative investments listed above are considered to be riskier than term deposits.

The key for an investor is to work out whether they prefer stability in the value of their investment – in which case bank deposits are a sensible option – or a higher, more stable income flow, whereby Australian shares may be more appropriate.

In any case, in the search for higher yield investors need to remain alert to opportunities while being aware of how particular shares or assets have performed in the past in relation to dividends.

But with a low-return outlook and uncertain prospects of capital gains, focussing on opportunities that have a track record of delivering reliable earnings and distribution growth is important if investors are to generate solid returns and meet their investment and financial goals.

 


Important notes

 

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

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