SHARES GENERATE INCOME.

Transcription

1 SHARES GENERATE INCOME.

2 BELL POTTER COMMITTED TO PEOPLE, BUSINESSES AND COMMUNITIES. Bell Potter Securities Limited was founded by Colin Bell in Australia in We have grown to be one of Australia s largest, full-service stockbroking firms providing financial services to institutional, corporate and retail clients. We specialise in delivering a customised service dedicated to achieving our clients strategies and goals. Since inception, our organisation s objective has been to offer a complete range of financial products and services that meet our clients needs. Our strength lies in being able to provide focused investment solutions for all our clients from individuals to corporations and institutions. Bell Potter is part of the Bell Financial Group of companies (ASX code: BFG).

3 INTRODUCTION We continue to live in an ultra-low interest rate environment, with Central Banks in developed countries continuing to play an unprecedented role in stimulating economic growth through quantitative easing and monetary policy measures. This trend of Central Bank involvement has continued in Australia with the Reserve Bank of Australia (RBA) keeping interest rates at the historically low rate of 2.5%. Therefore, investors who are still heavily overweight in cash or cash products are being forced to rebalance their portfolio to increase their exposure to risk assets, which generate a higher rate of income. By reviewing the current investment environment and examining how equities have performed against other asset classes, this report builds a compelling case as to why investors should be invested in equities. In this report we will demonstrate how maintaining a well constructed, diversified equities portfolio can provide exceptional opportunities to generate growth and income through tax effective dividends. WE WILL SHOW YOU, OVER THE LONG TERM, SHARES GENERATE INCOME. SHARES GENERATE INCOME. 1

4 1.0 WHAT S GOING ON GLOBALLY? Investors face the perpetual dilemma between risk and reward; between preserving capital and generating growth. Now however, they face this dilemma in an environment of modest global economic growth and lower interest rates. The level of volatility and uncertainty surrounding the financial markets has abated, reflecting better economic data in response to strong accommodative monetary policies adopted by Central Banks in the large advanced economies. The strong austerity measures that were adopted in the Eurozone saw the threat of bankruptcy in the PIIG (Portugal, Italy, Ireland & Greece) nations avoided, while the Bank of Japan (BoJ) has now adopted an aggressive monetary easing policy aimed to boost economic activity and combat deflation. Along with these aggressive interventionist actions, the Central Banks of the developed world have keep interest rates at historically low levels. However, even with the interventionist policies of the developed world s Central Banks, growth in most advanced economies has remained subdued, unemployment has remained elevated, and these economies are likely to continue to face headwinds for some time to come. In contrast, there has been relatively strong growth in the Asian economies, with signs that the Chinese economy, in particular, has stabilised. The Chinese government has also engaged in public spending to encourage economic activity. 2

5 And perhaps the most encouraging sign of economic improvement is the fact that the US Federal Reserve has begun tapering its monthly bond and mortgage backed security purchases. The US central bank has trimmed its monthly purchases from US$85 billion to US$35 billion. We are currently forecasting the Australian economy to grow by around 3% in both 2014 and The improved economic growth is largely driven by a combination of higher wealth, improving business confidence, lower interest rates and a recovering global backdrop. This should see a reasonable pick-up in consumption and housing, and stronger exports post the mining boom. However, the slowdown in mining activity and falling commodity prices will limit this pick-up in economic growth. Australia s non-mining sectors have experienced strong headwinds to growth due to a strong Australian dollar, which has been strongly supported by international investors. We are currently forecasting the Australian economy to grow by around 3% in both 2014 and The improved economic growth is largely driven by a combination of higher wealth, improving business confidence, lower interest rates and a recovering global backdrop. SHARES GENERATE INCOME. 3

6 2.0 PERFORMANCE OVER TIME It is important that our analysis takes into account the real life impact of tax and costs on ultimate investment returns. As such, the following two charts look at the performance of various asset classes over the past 20 and 10 years ended July Year Investment Returns - after tax and after costs Over the 20 year period, Australian shares outperformed all other asset classes at both the lowest and highest marginal tax rates returning 10.0% p.a. and 7.9% p.a. respectively. Residential investment property achieved the second highest return of 8.6% p.a. and 6.8% p.a. at the lowest and highest marginal tax rates respectively. Taking into consideration the difficult economic conditions post 2007 and the perceived buoyancy of the residential property market through this period, it is a thought provoking result. Australian bonds delivered a return of 6.0% p.a. and 3.9% p.a. respectively over this period. It is interesting to note that those on higher incomes and taxes over this period would have been better off investing in Australian shares, residential investment property, Australian Real Estate Investment Trusts (A-REITs), and hedged overseas shares. Chart 1: Asset Class Investment Returns for the 20 years to Returns (%p.a) Australian Shares Residential Investment Property Australian REITs Australian Bonds Gross Return After-tax lowest marginal tax rate After-tax top marginal tax rate Super Cash Overseas Shares (hedged) Overseas Shares (unhedged) Source: Russell Investments / ASX Long Term Investing Report July 2013 Note: All returns are net of costs. Past performance is not a reliable indicator of future performance 4

7 Chart 2: Asset Class Investment Returns for the 10 years to Returns (%p.a) Australian Shares Residential Investment Property Australian REITs Australian Bonds Cash Overseas Shares (hedged) Overseas Shares (unhedged) Gross Return After-tax lowest marginal tax rate After-tax top marginal tax rate Super Source: Russell Investments / ASX Long Term Investing Report July 2013 Note: All returns are net of costs. Past performance is not a reliable indicator of future performance 10 Year Investment Returns - after tax and after costs Over the 10 year period, Australian shares were the best performing asset class at the lowest and highest marginal tax rate with returns of 9.2% p.a. and 6.9% p.a. respectively. Hedged overseas shares produced the second highest returns of 7.4% p.a. and 5.9% p.a. at the lowest and highest marginal tax rate respectively. In addition, the Australian share market has experienced less extreme fluctuations since the global financial crisis compared with the overseas share markets. In an environment of historical low interest rates globally, Australian bonds have produced returns of 5.2% p.a. and 3.3% p.a. respectively. Sovereign debt concerns facing the United States and a number of major European countries, combined with comparatively higher interest rates on Australian bonds, has contributed to foreign ownership of Australian Government securities increasing from around 35% in June 2003 to the current 68%. SHARES GENERATE INCOME. 5

8 THE CASE FOR EQUITIES > GROWTH > DIVIDENDS > ANNUAL RETURNS > LOW VOLATILITY 6

9 3.0 THE CASE FOR EQUITIES - GROWTH We will now discuss the growth nature of equities. All Ordinaries The All Ordinaries Index, which is referred to frequently in the media, simply looks at the price movement of the share market. Below is a graph of the All Ordinaries Index from 1960 to 2014: Chart 3: All Ordinaries Index performance Global Financial Crisis 2000 Tech Wreck 1987 Sharemarket Crash 1973 OPEC Oil Crisis This graph demonstrates how equities perform as a growth asset over a long time frame. Even taking into account extreme market occurrences - the OPEC Oil Crisis in 1973, the 1987 Share Market Crash, the Tech Wreck of 2000 and the recent GFC of over the long term the All Ordinaries has still exhibited phenomenal growth. SHARES GENERATE INCOME. 7

10 3.1 THE CASE FOR EQUITIES - DIVIDENDS What the previous All Ordinaries chart does not take into account is the impact of dividends on the overall return of equities. To understand the importance of dividends and their impact we can compare the All Ordinaries Index to the All Ordinaries Accumulation Index, which takes into account not only price movement, but also the dividends paid by companies. Chart 4: Taking into account dividends - All Ordinaries vs. All Ordinaries Accumulation Index Source: IRESS When investing in shares you must never underestimate the importance that dividends play in creating wealth. Dividend income will materially enhance the total investment returns in a low growth and low interest rate environment, such as the one we are currently operating in. Chart 4 clearly shows how dividend income materially enhances the performance of shares. 8

11 3.2 THE CASE FOR EQUITIES - ANNUAL RETURNS The graph below shows the annual returns that the Australian share market has achieved from 1980 to The average annual return over the period from investing in the share market, and assuming that you also reinvested your dividends, is 13.9%, which does not take into account the effect of tax on the investment returns. Chart 5: All Ordinaries Accumulation Index Annual Returns Average = 13.9% Source: IRESS *Please note this average assumes all dividends are reinvested. SHARES GENERATE INCOME. 9

12 3.3 THE CASE FOR EQUITIES - LOW VOLATILITY The current level of volatility of the Australian share market is also relatively low as shown in the next chart. Chart 6: Australian Share Market Volatility Average = 22.4 Australian equities have performed strongly over meaningful timeframes even though there have been shorter periods of time in history when cash and bonds have outperformed shares. Moreover, history has shown that equities have delivered superior returns to other asset classes such as cash and bonds, especially taking into account the relative impact of tax. From this series of graphs we have seen: equities have performed their function as a growth asset notwithstanding volatile periods; dividends materially enhance the return of equities; the current volatility of the Australian share market is well below the historical average. 10

13 4.0 OPPORTUNITY KNOCKS... As demonstrated in this report, there is a variety of asset classes from which income and/or capital gains can be generated. Whether investors choose equities, cash, bonds or property will have a significant impact on the opportunity for capital and income growth. The opportunity cost which households will pay by remaining cautious and staying substantially invested in bank bills or bonds is very high. Currently, the 1-year forward consensus dividend yield for the Australian share market is 4.6% of which 80% is fully franked, and it is therefore equivalent to a grossed up dividend yield of 6.2%. This dividend yield is substantially above the current 90-day Bank Bill rate of 2.7%, the 12-month term deposit rates of around 3.3% and the 10-year bond yield of 3.8%. We believe that by maintaining a well-constructed, diversified equities portfolio, investors will be able to generate a higher level of income than they would by holding other assets. A balanced portfolio of cyclical and defensive stocks, with a continuing emphasis on relatively high dividend yields, is appropriate in the current circumstances. A portfolio of high quality, fundamentally strong businesses that are run by experienced management teams, bought at attractive share prices, will generate well above average returns for investors over the medium to long term. Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful. Warren Buffett SHARES GENERATE INCOME. 11

14 5.0 WHERE TO FROM HERE? While the scale of the recent turmoil in global markets has no doubt affected investor confidence, share market volatility is not new. It is important to remember that all investments regardless of asset class go through cycles of boom and bust. The key to generating ongoing wealth is to understand your investment requirements, to ignore the investing fad of the day and to focus on implementing strategies that have been proven over time. Successful investing is about having a long term perspective and the time invested in the stock market. It is also important to invest in companies that are fundamentally sound, which employ experienced management teams and deliver consistent dividends. Not trying to time the stock market is integral to creating wealth. Trying to pick the top or bottom of an equities cycle is extremely difficult and it compounds the risk of being out of the market if it should rally. While this strategy does not provide protection from market downturns, it does ensure investors benefit during times of market growth. When markets turn, they can turn quickly. History has shown that no single asset class outperforms year after year, which is why diversifying your investments can help to minimise risk. While portfolio diversification often starts with investing across different asset classes, it also includes holding a spread of investments within a single asset class. With the rise of different instruments listed on the ASX, it is now possible to gain exposure to different asset classes through your Bell Potter adviser. By ensuring that your portfolio has a mix of the various ASX listed assets that Bell Potter advisers have access to, you can take advantage of the benefits that diversification brings. A portfolio that is diversified and properly weighted is critical to delivering successful returns and minimising risk. Three examples of alternative assets that can help diversify your portfolio are Fixed Income products, Listed Investment Companies (LICs) and Exchange Traded Funds (ETFs). 12

15 FIXED INCOME Fixed income investments typically have a low correlation to the share market - meaning that a fixed income portfolio can potentially reduce volatility of an overall portfolio by adding diversification. Fixed income products include: term deposits, bank bills, bonds and ASX listed debt or hybrid securities. EXCHANGE TRADED FUNDS Exchange Traded Funds (ETFs) are open ended, ASX listed products which are made up of a portfolio of securities that track a specific index, sector, currency or commodity. In a single security, an investor can hold a basket of investments that can help diversify their portfolio in a relatively inexpensive way. LISTED INVESTMENT COMPANIES Listed Investment Companies allow investors to gain diversification through exposure to a portfolio of securities listed on the ASX, which are actively managed by professional investment managers in a cost-effective way. Over the long-term, investors can gain capital appreciation and consistent income from LICs. At Bell Potter we have dedicated specialists, who cover these three different products. We produce a number of different documents and independent research, which covers these various areas. If you would like to discuss your portfolio in the context of the current macroeconomic environment please contact us. info@bellpotter.com.au BELLS ( ) SHARES GENERATE INCOME. 13

16 The following may affect your legal rights: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arrangement with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document and Bell Potter assumes no responsibility for updating any advice, views, opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Past performance is not a reliable indicator of future performance. Except insofar as liability under any statute cannot be excluded, Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of Interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document(which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. 20 June 2014 Bell Potter Securities Limited Level 29, 101 Collins Street Melbourne VIC 3000 Australia GPO Box 4718 Melbourne VIC 3001 Australia Tel BELLS (23557) Fax ABN AFS Licence No