This article originally appeared in The Australian on 1 May 2020
High on the worry list for investors and prominent in the news this week is the issue of dividend cuts and whether investors can still meet their income targets.
National Australia Bank’s announcement on Monday to cut its dividend by two-thirds from 83c this time last year to 30c as well as to raise fresh capital at $14.15 a share surprised the market, but only in terms of timing.
Hot on the heels of NAB, Westpac announced a further impairment on Tuesday quite possibly their curtain raiser for an imminent dividend cut. (We will know on Monday.)
Separately, ANZ advised of a deferral of its dividend decision until its August trading update: so, no dividend at all from ANZ but no capital raising either.
Dividend cuts are here. All the banks and insurers are on notice from prudential regulator APRA to conserve capital while the real estate trusts are managing down investor income expectations. Many companies in the hardest-hit COVID-19 sectors have already suspended dividends.
It is worth noting on the NAB capital raise price of $14.15 a 60c annual dividend represents an income return of 4.2 per cent before franking credits, suggesting that the market adjustment of prices for the banking sector cum downwards dividend adjustments was just about perfect.
Many investors — especially retirees — target an income amount for each year and this requirement is central to their investment objectives.
In normal economic conditions, achieving an income investment objective has been a relatively straightforward matter. Indeed, for many asset classes the income component of total return (income + growth = total return) has been both the steadiest and the lion’s share component of the total return.
The biggest threat to achieving the income investment objective until now has been steadily declining interest rates, which have dragged down returns on all asset classes.
But now in the post-COVID-19 earnings-unpredictable world (with the vast majority of ASX 200 companies having withdrawn their earnings guidance), a substantial threat to achieving income objectives has arisen in all but fixed-interest securities.
The same investors who have an income investment objective typically also have a secondary investment objective, which is to protect and grow their capital base. That objective might be expressed, for example, as growing the capital base by at least CPI/inflation.
Generally, these investors exhibit great reluctance to “eat into” their capital base. They want the pie to keep growing. They are reluctant to realise taxable capital gains. They may prefer to tighten their spending belts rather than supplement income through selling down some assets even when those assets had experienced above-average growth.
But here we are about to embark on planning for the 2020-21 financial year in which there is largely fog where income predictability used to be. Should we care whether the companies we are invested in pay us dividends or retain the cash to enhance the longer-term capital value of the business? The answer is that in today’s environment if it’s a good business that will recover strongly and company management is sound, we shouldn’t care.
With capital values of investment portfolios likely to end the financial year lower than they began it, many already have or could realise capital losses this financial year.
For taxable investment portfolios, realised losses create an opportunity to generate offsetting gains, which may make selling a component of future price growth much more palatable. Indeed, post the NAB dividend cut, some sell-side brokers are now positive on the outlook for NAB — stockbroker Morgans on Tuesday published a $16.50 target price, representing a 16 per cent rise on the capital raising price on top of the 4.2 per cent dividend return — a potential 20 per cent total return.
For non-taxable investment portfolios, the argument for being indifferent between taking returns from income or price gains are even stronger.
Total return is the most relevant way to measure the success of investment portfolios. Investors should worry far less about dividends and be more concerned about company strength and growth potential.
Other ways investors can use these COVID-19 disrupted markets to reduce their current and future worry include:
- Exiting investments that once were “no sells” because of high, embedded capital gains;
- Building up a solid cash buffer to cover all expected expenditure needs as well as emerging opportunities;
- Reducing the complexity of investment structures by rationalising to fewer portfolios;
- Switching investments into more tax-effective investment structures;
- Considering the use of professional super funds, investment fund managers and/or financial advisers;
- Ensuring a good balance of defensive assets that will protect in the event of a retesting of market lows together with assets that will participate in a market recovery;
- Ensuring a good exposure to market sectors most likely to suffer less or recover strongly from the current crisis.
Sue Dahn is a partner at Pitcher Partners and was recently voted No 1 among Australia’s top financial planners in The List: Australia’s Top Financial Advisers.
The views expressed in this article are provided by Pitcher Partners Investment Services and do not represent the views of any other Pitcher Partners financial services licensees.
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