October 26, 2017
October 26, 2017 | Investments Insightz
Delivering consistent income for conservative investors
Telstra’s recent woes serve as a useful reminder, if any were needed, that delivering consistent income while preserving capital can be challenging. This was Telstra’s first cut to its dividend since listing in the late 1990s and whilst it should move the company’s distribution policy to a more sustainable footing, the harsh reality is that Telstra investors will be seeing a 30% reduction in their income next year.
For that (increasing) part of the population that has the dual objective of achieving a steady income to fund retirement while at the same time preserving capital to address longevity risk (or the risk of outliving their savings), these developments at Telstra are sobering. And not because anyone is overly relying on Telstra alone to deliver on their objectives, but because this experience is symptomatic of the broader industry challenge of generating income (and preserving real capital) in an environment where not only interest rates are low – and expected to stay low for an extended period - but equity valuations are also relatively high.
And while we know that exposure to equities provides a solution to longevity risk, the fluctuations – at both the company and market level – can be concerning. Given this, it is perhaps surprising that retirees are not looking more closely at Equity Income Funds to address the needs of providing consistent and stable income while dampening volatility and providing the opportunity for capital growth.
A typical Equity Income strategy is to buy a portfolio of blue-chip stocks to provide equity exposure and access to dividends, and over which exchange-traded option strategies can be employed to both supplement income and manage the exposure – and volatility – of the overall portfolio.
In essence, options are used to convert some future capital gains into upfront income, or option premium. Some of this premium can be used to supplement income distributions from dividends and some can be used to control risk, allowing for better management of up and down markets. Properly managed equity income funds are an excellent way to generate regular income and at the same time capture the benefits of equity market exposure.
This takes manager skill. The pioneers in this space are Denning Pryce, a boutique asset management company established in 2006. Widely acknowledged as experts in derivatives markets, the principals have over 50 years’ combined experience in senior positions within the securities industry. Denning Pryce is also the manager of the Zurich Investments Equity Income Fund, which has recently celebrated its 11th birthday.
Since inception*, the fund has consistently generated and delivered income on a monthly basis across all market conditions. The Fund aims to provide investors with 7% to 9% gross running yield over rolling 3 year periods. Careful consideration is also given to providing investors with distributions that are the most tax effective.
An often over-looked benefit of this type of equity strategy, particularly in bull markets, is the protection against some downside risk that it can provide during a market draw-down. This was particularly telling during the GFC. In the Financial Year to June 2009, when the S&P/ASX 50 fell 18%, Zurich’s Equity Income Fund fell only 6% (and less if franking credits are included). The Fund uses options to deliberately reduce and control equity exposure.
Nor should it be thought that using options has to be risky. Any option position employed by this Fund is fully covered, either by stock or cash-backed, meaning that it doesn’t involve any financial leverage.
Since inception, the fund has delivered equity-like returns, but with reduced volatility and risk. Since inception to the end of September 2017, the fund has delivered 4.28% p.a. (6.19 p.a. if franking credits are taken into account), which compares favourably to the S&P/ASX50’s 5.74% p.a. return. The use of options has also dampened portfolio volatility**, meaning that a more risk averse investor can get the equity exposure they need without the same level of risk as a traditional equity fund.
Given current market valuations, as well as the ongoing need for income, perhaps it is time for conservative investors to revisit Equity Income Funds as a robust solution to deliver attractive levels of tax effective and regular income with the opportunity for capital growth.
* Inception date for the Zurich Investments Equity Income Fund was 3rd October 2006.
** The standard deviation of the Zurich Investment Equity Income Fund was 10% pa for the period since inception to the end of September 2017; the standard deviation of the ASX/S&P 50 over the same period was 13.5% pa.
Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated 24th October 2017, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance. GINN FVHHKJ.00012.ME.036.
CSTT – 012928-2017