Why you might care

Chart 1: Australian and Global Equities Portfolio – Historical Income Chart 2: Australian and Global Equities Portfolio – Historical Price Only Return

PORTFOLIO ALLOCATION AT BEGINNING OF PERIOD: 50% AUSTRALIAN EQUITIES; 50% GLOBAL EQUITIES. SOURCE: STATE STREET GLOBAL ADVISORS, S&P, MSCI

PORTFOLIO ALLOCATION AT BEGINNING OF PERIOD: 50% AUSTRALIAN EQUITIES; 50% GLOBAL EQUITIES. SOURCE: STATE STREET GLOBAL ADVISORS, S&P, MSCI

when they report their returns. For retirees and their advisers who are comfortable with this way of thinking, we would be reluctant to force change. This is especially true for retirees with most of their superannuation in a large superannuation fund. Trying to distinguish between income and capital gains for these investors will only cause confusion.

SMSFs and assets outside superannuation

So, if thinking about income may not be helpful for retirees in large superannuation funds, who might find it helpful? We think there are two groups where a focus on income may provide benefits.

The first is self-managed super funds (SMSFs) in pension mode. Retirees using SMSFs have more control over their investments and can easily see whether their investment returns are being driven by capital gains or by income.

The second is retirees with significant assets outside superannuation. This may be anything from investment property, to listed shares to exchange traded funds (ETFs) to managed funds.

Mental accounting and market volatility

We, along with many others in the industry, believe that most new retirees need to keep a healthy exposure to growth assets because most new retirees still have 20 to 30 years of investing ahead. Unfortunately, growth assets are usually more volatile, and that leaves retirees exposed to sudden market falls. Sudden market falls can lead to panicked investors, just itching to sell their investments. Or they can cause investors to worry that their superannuation will run out much sooner than expected.

This is where the idea of “income” can be powerful, particularly for growth assets. Provided an equity or growth portfolio is well diversified, its income is likely to be surprisingly stable. To demonstrate this, take a simple portfolio split equally between Australian equities and global equities, with no rebalancing – just “buy-and-hold”.

The chart below shows the historic income from dividends that this portfolio would have generated. All numbers have been adjusted for inflation, so they represent “real income”. The opening balance is $1 million in today’s terms (equivalent to just over $300,000 in 1983).

Over this 35-year period, this simple equity portfolio shows steadily rising dividend income. Certainly there are periods where dividends contract. Most notable was the global financial crisis (GFC) where dividends of close to $120,000 on this portfolio fell to just over $80,000.

However, compare this variability in income with variability in price. The second chart shows one-year price returns Continued on page 14

Continued from page 13

for the Australian and Global components of the portfolio. This is the kind of intimidating volatility investors associate with equity or growth investing.

Encouraging retirees to focus on income, especially dividend income, allows them to mentally quarantine their pension needs from shorter term price volatility. We believe it helps investors hold steady during market sell-offs.

Investment benefits of income

But there is a second reason for focusing on investment income, and particularly dividend income from equities. A number of research datasets suggest that companies with higher dividend yields tend to outperform over the very long term. High dividend yield investing is not for everyone; it involves accepting significant style biases in a portfolio. Investing for dividend yield may have a good very long-term track record, but shorter performance has been much more mixed, with extended periods of both market outperformance and underperformance.

Table 1: High Equity Yield Performance

Data Set Market

Kenneth R. French3 US Kenneth R. French3 US Kenneth R. French3 Dev. ex-US S&P Global Aristocrats All World S&P High Dividend Yield US MSCI World Dividend Tilt Developed MSCI ACWI Dividend Masters All World

Excess (% p.a.) Period Time (yrs) Notes 1.4 6/1927 – 12/2018 91.5 Highest 30% vs. market return 1.4 12/1974 – 12/2018 44.0 Highest 30% vs. market return 3.3 12/1974 – 12/2018 44.0 Highest 30% vs. market return 1.3 12/2001 – 1/2019 17.1 Excess return vs. MSCI ACWI 4.4 12/1999 – 1/2019 19.1 Excess return vs. S&P500 1.0 11/1998 – 1/2019 20.2 Excess return vs. MSCI World 2.8 11/2002 – 1/2019 16.2 Excess return vs. MSCI ACWI

SOURCE: STATE STREET GLOBAL ADVISORS, KENNETH R. FRENCH, S&P, MSCI

The table above summarises findings from three datasets covering high equity yield strategies for US and global equities.

While it may be true that total return should count more than income, it is not true that focusing on income automatically comes at the expense of total return. In fact, the very long-term historic data suggests the opposite.

Conclusion We believe SMSF investors who focus on income are better able to mentally quarantine price volatility in their growth assets from their regular pension requirements. That makes it easier for a retiree and their adviser to buy and then hold onto growth assets in their portfolio.

This mental quarantine is helpful regardless of style biases within the portfolio. However, for investors willing to take a very long-term view, there is evidence to suggest higher dividend yield companies tend to outperformance over the very long term.

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Are APRA’s heatmaps in social isolation?

Rollover offers a big shout out to the girls and boys at the Australian Prudential Regulation Authority (APRA), particularly those involved in the superannuation funds heatmaps exercise.

Given the investment fall-out from the COVID-19 pandemic, Rollover is wondering what sort of colours are showing up the heatmaps of all those funds who were focussing on growth rather than capital preservation.

Rollover knows that APRA has been communicating with a number of superannuation funds seeking regular updates regarding their liquidity in the face of high levels of switching and, of course, the hundreds of thousands of members who have contacted the Australian Taxation Office (ATO) about drawing down $10,000 in hardship early access to their accounts.

Given all of the above, the question is whether APRA has time to work on its heatmaps and, if it does, what will they look like given what represents rapidly-changing circumstances and the need to factor in membership demographics.

Rollover hears tell it could be the back end of 2021 before the APRA team feel brave enough to undertake another heatmap exercise.

HOW THE WHEEL TURNS

It seems only a few short years ago that superannuation policy guru and sometime Super Review columnist, Blake Briggs, packed his swag and left the Financial Services Council for what looked like a pretty cushy job over at Westpac as head of government affairs for wealth.

But how things change in two years. Westpac has largely exited wealth leading Rollover to conclude that Briggs’ move was not so much a case of returning to the mother ship, but actually finding a convenient career life raft.

Not that Briggs is actually discernibly taking a backward step. Oh no. He left the FSC as senior policy manager, superannuation, and returns as deputy chief executive, under Sally Loane.

Rollover can’t remember the last time the FSC had an official deputy chief executive but he does remember that when Richard Gilbert was chief executive of its forerunner, the Investment and Financial Services Association, he had a deputy, John O’Shaughnessy.

Hello, hello is anyone there? Rollover doffs his cap to all those superannuation industry operatives who have begun working from home, but after three weeks on the home front he is beginning to wonder whether some people are as focussed as others.

Of course, there are those who, when Rollover dials their number, they pick up as promptly as ever but then there are others who, well, the phone just rings and rings.

Now, your correspondent entirely gets that working from home is not easy when parents have to balance their work with managing young children, but he is wondering whether some of his contacts might be catching up on Netflix or having a snooze in the big, red chair.

No names, no pack drill at this stage, but Rollover is keeping a list.