Decreasing yields and looking beyond traditional income strategies

Trend Hunter Series

Decreasing yields and looking beyond traditional income strategies Falling yields were already one of the biggest challenges facing retirees with traditional fixed-income strategies sometimes falling short of expected portfolio returns. In this presentation, Evergreen Consultants, DNR Capital and Innova AM, share how they are supplementing income whilst managing risk-adjusted returns.

27 August 2021 This document is for general use. Modification of content is prohibited unless you have Netwealth’s express prior written consent.

Before we get started

The views expressed in this presentation are those of the author and presenter and do not necessarily reflect those of Netwealth Investments Limited’s. It is a general summary only. It is not advice nor an endorsement of any product or service.

Netwealth Investments Limited (Netwealth) (ABN 85 090 569 109, AFS Licence No. 230975) is a provider of investment products and services and information contained in this presentation is of a general nature which does not take into account yours or your client’s individual objectives, financial situation or needs. Any person considering a financial product or service from Netwealth (or its related parties) should obtain the relevant disclosure document at www.netwealth.com.au and consider consulting a financial adviser before making a decision and before deciding whether to acquire, dispose of, or to continue to hold, an investment in any Netwealth (including its related parties) product.

Whilst reasonable care has been taken in the preparation of this presentation using sources believed to be reliable and accurate, to the maximum extent permitted by law, Netwealth and its related parties, employees and directors are not responsible for, and will not accept liability in connection with any loss or damage suffered by any person arising from reliance on this information.

This presentation is for general use. Modification of content is prohibited unless you have Netwealth’s express prior written consent.

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Housekeeping

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Meet today’s Trend Hunters

David Cohen

Senior Analyst

Evergreen Consultants

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Dan Miles

Scott Kelly

Innova AM

DNR Capital

Managing Director & Co-CIO

Portfolio Manager

Evergreen Consultants David Cohen

Senior Analyst

Evergreen Consultants

Evergreen Consultants Decreasing yields - Looking beyond traditional income strategies

The Search for Yield • •

The Monetary Policy response to the GFC and more recently Covid-19 has left traditional defensive assets delivering negative real yields and at risk of failing to meet Portfolio objectives Cash rates were reduced to the effective lower bound (or below)

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The Search for Yield • •

Assessments of the Real Neutral Interest Rates have adjusted lower Bond yields declined and have been further suppressed by Quantitative Easing (QE)

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The Search for Yield • • • • • •

We expect yields to rise although remaining below historical levels Investors have been forced to take additional risk to meet objectives Equity dividend yields remain well above prospective bond yields Franking credits (in Australia) provide additional income benefits Infrastructure and REITs may have a role to play for inflationlinked cashflows and high yields We do not consider equities as a replacement for a defensive allocation but advisers can use the income in a multi-sector Portfolio to supplement income requirements 11

The bottom of inflation?

• •

Inflation has remained below expectations since the GFC whether looking at headline or core CPI measures We expect higher inflation going forward

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The bottom of inflation?

• •

The path of inflation will be an important question moving forward as will be the response of Monetary Policy There are three likely scenarios with varying impacts on markets

Scenario

Equities

Rates

Credit

Inflation subsides and the low-growth, low-inflation World resumes

Positive

Positive

Positive

Short-term spike in inflation returning toward Central Bank target levels

Positive

Neutral/ Negative

Neutral

Inflation remains elevated above targets requiring Monetary Policy response

Negative

Negative

Negative

•

Our base-case is the central scenario 13

Defensive Allocations • •

With cash rates starting at the ELB and the possibility of rising bond yields, defensive portfolios are challenged How do we respond?

1. Maintain short duration positions – capture some income from term premium and retain the benefits of negative equity correlation. Adds value in the low-growth scenario but neither a major contributor nor detractor in the normalizing scenario 2. Overweight credit through high-grade floating rate and securitized asset exposure – the additional spread provides greater income to meet objectives and less susceptible to either of the low growth or normalizing inflation scenarios 3. Seek alternative strategies – low volatility alternatives, inflation-linked assets, active duration and long volatility for uncorrelated returns in the high inflation scenario

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Disclaimer This presentation has been prepared by Evergreen Fund Managers Pty Ltd, Trading as Evergreen Consultants, AFSL 486 275, ABN 75 602 703 202 and contains general advice only.

This presentation is intended for Advisers use only and is not to be distributed to retail clients without the consent of Evergreen Consultants.

Information contained within this presentation has been prepared as general advice only as it does not take into account any person’s investment objectives, financial situation or particular needs. The presentation is not intended to represent or be a substitute for specific financial, taxation or investment advice and should not be relied upon as such.

All assumptions and examples are based on current laws (as at July 2021) and the continuance of these laws and Evergreen Consultants interpretation of them. Evergreen Consultants does not undertake to notify its recipients of changes in the law or its interpretation. All examples are for illustration purposes only and may not apply to your circumstances.

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Innova AM Dan Miles

Managing Director & Co-CIO

Innova AM

NETWEALTH TREND HUNTERS SERIES DECREASING YIELDS & LOOKING Innova Asset Management: BEYOND TRADITIONAL Risk-DefinedINCOME Portfolios STRATEGIES March 2018 2021

CONCEPTIONS & ALTERNATIVES • Typically, debt-type assets used as the cornerstone of income-production – difficult in a world of zero to negative rates.

• A number of options available, not all necessarily a good idea: • Typical and popular approach is to move out the risk curve – this is somewhat dangerous.

• Yield can be derived from alternative sources, such as equities, property etc. however capital risk needs to be appreciated.

• Yield can actually be derived from anywhere – as long as the underlying growth is sustainable and sufficient to fund this move.

• Feel free to refer to reference document at innovaam.com.au: https://www.innovaam.com.au/portfolio-insights-2017-slaughtering-sacred-cows/ 18

‘CHASING YIELD’ IS DANGEROUS

Not an attractive purchase point

Source: https://fred.stlouisfed.org/

• In many higher-yielding instruments, investors are not being compensated for taking more risk – need to be selective in approach.

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OTHER OPTIONS • Options in this environment: • Use a high-grade credit manager and accept a 1.5% - 2% return over cash?

• Combine this with a Government bond manager who focuses on real yield?

• Allocate more to real-yielding property and sustainable dividends?

• Individually these strategies should provide higher yield, though has the potential to take on excessive capital risk.

• Our preferred approach: • A total-return approach and deriving yield from a combination of sustainable capital growth and yield.

• Use a well-constructed portfolio that can generate the same levels of return without taking excessive risk.

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DISCLAIMER This document has been prepared by Innova Asset Management Pty Ltd, ABN 99 141 597 104, which is a Corporate Authorised Representative of Innova Investment Management Pty Ltd, AFSL 509578.

The information contained in this document is commentary only. It is not intended to be, nor should it be construed as, investment advice. The views expressed are subject to change at any time based on market and other conditions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider your particular investment needs, objectives and financial circumstances.

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DNR Capital Scott Kelly

Portfolio Manager

DNR Capital

This document is for general use. Modification of content is prohibited unless you have Netwealth’s express prior written consent.

Decreasing yields & looking beyond traditional income strategies

Scott Kelly DNR Capital This document is intended for financial advisers and researchers only. DNR Capital does not authorise distribution to retail investors.

© DNR Capital 2021

Business background

Snapshot

Difference

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Founded in 2001

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Employee owned

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Concentrated portfolios with high conviction ideas

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Targeted and efficient process, focused on quality

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Strongly aligned and highly accountable

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History of strong transparency

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Winner - Money Management SMA Manager of the Year 2020

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IMAP Managed Accounts Awards - Australian Equities 2019 finalist

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IMAP Managed Accounts Awards - Australian Equities 2018 finalist

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Winner - Money Management/Lonsec SMA Portfolio Award 2017

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Money Management/Lonsec SMA Manager of the Year 2016 finalist

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Money Management/Lonsec SMA Manager of the Year 2015 finalist

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Golden Bull Award finalist in 2014 Australian Fund Manager Awards

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Winner - Best SMA Portfolio 2014 by Lonsec

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Golden Calf Award finalist in 2011 Australian Fund Manager Awards

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Clearly positioned basket of Australian equity portfolios As at 31 July 2021

High Conviction Strategy

Socially Responsible Strategy

Income Strategy

Emerging Companies Strategy

Large cap

Mid cap bias

Large cap

Small cap

Experience

Est. Oct 2002

Est. June 2006

Est. Dec 2007

Est. Dec 2017

Focus

Capital growth

Socially responsible

Growing, tax effective income

Capital growth from smaller companies

Results

3.2% p.a. alpha since inception

3.6% p.a. alpha since inception

2.1% p.a. alpha since inception

17.1% p.a. alpha since inception

Quality stocks at attractive prices (style neutral) 18+ years of outperformance Past performance is not an indication of future performance. No allowance has been made for taxation and fees are not taken into account.

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Traditional sources of income • Traditional sources of income (i.e. cash, fixed income, property etc.) have deteriorated over last ~20 years. Meanwhile, gross dividend yields remain broadly stable.

• Alternative sources of income may not cover inflation pressures. Retirees need to adjust lifestyles, eat into capital or move up the risk curve.

Traditional sources of income (now & then) 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%

ASX 200 gross dividend yield (CY)

Aus housing gross rental yield 1993

Source: Factset, RBA, SQM Research

Aus 10 yr bond yield

Bank 12 mth term deposit rate

2021

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Reliability of equity income • Net dividend yields (excluding franking) have consistently averaged ~4% pa over the last ~30 years, whilst bond yields have declined from ~8% to ~1%.

• Of course there have been disruptions to dividends (e.g.. GFC, COVID-19), however they have historically recovered reasonably quickly.

Australia 10-year Bond Yield versus ASX200 Equity Yield

Source: Iress

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Reliability of equity income • Dividends will continue to be a large contributor to market returns, having contributed approximately half the ASX200 index returns since 1950.

• This is primarily due to the benefits of franking, which remains a key differentiator for Australian investors, relative to other markets.

ASX200 Contribution to Annual Return

Source: Iress

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Dividend recovery • Following a decline of ~40% in CY2020 dividends, CY2021/22/23 are expected to rebound strongly, driven by higher earnings and a recovery in payout ratios. This currently represents a gross yield including franking of ~6%.

• The declining profile across 2021-2023, represents the market view of declining commodity prices and reduced capital management intentions as economic conditions normalise.

ASX200 Dividends Paid

Annual rebasing of dividends applied to ASX200 Source: Iress, FactSet

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Sources of yield shift over time • In 2020, Financials were hit hard with recession headwinds and regulatory intervention, whilst Resources companies are faring well as high commodity prices help generate significant free cash.

• Active portfolio management / stock selection can have a significant impact on income generation.

ASX200 Sector Contribution to Yield (FY) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Communication Services

Consumer Discretionary

Consumer Staples

Energy

Financials

Health Care

Industrials

Information Technology

Materials

Real Estate

Utilities

Source: FactSet

2021

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Equity income strategies DNR Capital focuses on growing $ income

Growing $ Income • Offset inflation / Maintain lifestyle  • Potential capital growth  High yield • Yield traps x • Capital deterioration x

Australian Equities Income Options

Derivative overlay • Downside protection  • Limited upside capture x • Costly / Complicated x Dividend stripping • Quant driven / Not fundamental x • High turnover x Low volatility • Limited upside capture x • Concentration risk x

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Primary income sources We broadly categorise companies as one of the following: Current examples Compounders - A company with a strong competitive position within a robust industry structure that has the capacity to deliver an average market income, with sustainable above market income growth.

IPH, MQG

Growers - A company that is delivering a sustainable below market income, however has the potential to deliver above market income growth.

ALX, SEK

Cows - A company with a solid balance sheet and capital management potential (i.e. – higher payout, special dividends, buybacks) that is being under-valued on traditional earningsbased metrics.

QUB, SUN

Yielders - A company that is delivering sustainable and cashbacked dividends, however with minimal (or no) income growth and where potential income growth.

NAB, TLS

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Portfolio holdings – Income strategy How we are positioned

Balance between quality leaders / defensive and COVID-19 recovery plays

Quality leaders / defensives

COVID-19 recovery plays

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DNR Capital Australian Equities Income strategy well positioned • The outlook for equity dividend yields remains appealing on a risk / return basis.

Yield Comparison - next 12 months 7% 6% 5% 4% 3% 2% 1% 0%

DNR Income Strategy

ASX 200

ASX 200 Industrials

Aus housing rental yield

Aus 1 yr bond yield

Aus Cash yield

2021 Yield

Gross

Source: FactSet, SQM Research, Iress

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Disclaimer

IMPORTANT NOTE: This document has been prepared by DNR Capital Pty Ltd, AFS Representative– 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658. It is general information only and is not intended to be a recommendation to invest in any product or financial service mentioned above.

Whilst DNR Capital has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and you must make your own enquiries concerning the accuracy of the information within. Past performance is no guarantee of future performance. The information in this document has been prepared for general purposes and does not take into account the investment objectives, financial situation or needs of any particular person nor does the information constitute investment advice. The portfolio data (including performance data) in this document relates to the DNR Capital model portfolio. The portfolio data in this model portfolio through a Portfolio Service may be different to the data in this document as a result of different policies and procedures at different Portfolio Service operators.

Before making any financial investment decisions you should obtain legal and taxation advice appropriate to your particular needs. Investment in a DNR Capital individually managed account can only be made on completion of all the required documentation. If you invest in the DNR Capital model portfolio via a service such as investor directed portfolio service, managed account service of separately managed account (“Portfolio Service”), you can obtain information from the Portfolio Service operator. If you invest via a Portfolio Service, different terms may apply to your investment. You should read the disclosure document for that Portfolio Service and consider your circumstances prior to investing.

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Questions and answers

Thank you Trend Hunters Series – Coming up • Mon 30th Aug at 1pm – Managing volatility in retirement – lessons learnt during the Covid crisis • Tue 31st Aug at 1pm - Outside the NASDAQ: Where to next for technology stocks?

• Wed 1st Sep at 1pm - International investing: Your guide to emerging markets and the new world economy

Portfolio Construction Podcast In this podcast series, our investment research team pick the brains of key wealth management professionals to uncover unique insights on the investment areas they are most passionate about.