How equity income funds can provide regular and higher income with lower volatility for investors Patrick Noble August 2009 1
Important Information This information is general in nature and does not take into account personal objectives, financial situations or needs and is not a personal recommendation about any securities, stocks or options mentioned. This presentation has been prepared specifically for the exclusive use of financial advisers, researchers and trustees. It is not to be published without the prior written consent of Zurich Financial Services Australia Limited ABN 11 008 423 372. Unless otherwise indicated the information in this presentation is, dated September 09, is given in good faith and has been derived from sources believed to be accurate as at this date and is subject to change. However, it should not be considered as a comprehensive statement on, or study of, any matter and should not be relied on as such. Neither Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511, Zurich Australia Limited ABN 92 000 010 195 AFSLN 232510 nor any related entities, or any of their employees or directors (Zurich) give any warranty of reliability or accuracy and to the fullest extent possible under law, accept no responsibility arising in any way whatsoever including by reason of negligence for errors or omissions. Investors should consider the Zurich Investments Equity Income Fund PDS when making financial decisions about the fund. The PDS is available for your financial adviser or Zurich. Past Performance is not a reliable indicator of future performance. Zurich Australia Limited ABN 92 000 010 195 AFSL 232510 Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 5 Blue Street North Sydney NSW 2060 Phone 1800 500 655 PNOE-003197-2009 2
Australia s population is ageing Percentage of population older than 65 25% 20% 15% 10% 5% 0% 2001 2011 2021 2031 2041 2051 65+ yrs Source: Australian Bureau of Statistics
And living longer 90 Australian life expectancies 85 80 75 70 65 60 55 50 1901-10 2004-06 Male (at birth) Female (at birth) Male (at 65) Female (at 65) Source: Australian Bureau of Statistics
Not so super $250,000 $200,000 $150,000 $100,000 $50,000 Retirement income and longevity Mean super balance 2007 $141,900* Comfortable lifestyle single $37,822 p.a. $0 0 5 10 15 20 Mattress 5.0% 7.5% 10.0% 12.5% Drawdown of $35,000 per annum * Mean accumulation balance for 55 64 year olds Source: The Westpac ASFA Retirement Standard; APRA
Many caught off guard by crisis Poor risk management processes High levels of leverage Obscure and complex structures Liquidity problems
Falling share prices and high volatility 90 80 70 60 50 40 30 20 7000 6500 6000 5500 5000 4500 4000 3500 10 3000 Jul 07 Nov 07 Apr 08 Sep 08 Feb 09 Jun 09 VIX (LHS) S&P/ASX 200 (RHS) Source: Bloomberg, Zurich Investments 7
Income challenge - Investment issues Income, what are the options? Will normalised interest rates circa 5.5% be sufficient? Rising bond yields; inflation or deflation? Volatile equity markets and dividend cuts Downside protection relevant for all investor portfolios
Strategies for volatile markets Well known strategies Less familiar strategy Diversification Re-balance portfolios to defensive allocations Stay focused on the long term Use exchange traded options to get a defined risk reward outcome Source: Denning Pryce; Zurich Investments 9
Options basics Exchange components of risk and return Call option The buyer of a call option has the right to purchase shares at a set price in the future in return for paying a premium to the seller (also known as the writer). Put option A buyer of a put option receives the right to sell shares at a set price in the future. By purchasing a put option, investors receive some downside protection should the shares fall below the (higher) specified price. Source: ASX; Denning Pryce
Options can be used in many ways Speculative Unlisted Conservative Listed No shares held Held over shares Magnify returns Smooth returns Magnify losses Protect against losses Gearing Enhance income Source: Zurich Investments
Meeting the challenges with options 1 2 3 Generate income in all market conditions Provide some downside protection in falling markets Deliver conservative growth Source: Denning Pryce; Zurich Investments
The Covered Call or Buy Write strategy $6 $4 Buy write strategy Involves selling call options to generate additional income over and above dividends from shares held in an underlying portfolio. $2 $0 M P $6 $8 $10 $12 $14 $16 -$2 -$4 -$6 Source: Denning Pryce; Zurich Investments
The Buy Write - Historical outcomes Buy Write Portfolio All Ords/ S&P/ASX 200 Accum Index Buy Write Portfolio Performance Relative to Index Bank Bills Quarterly Returns Number of quarters 60 60 60 60 Mean 2.96% 2.40% 0.56% 1.98% Median 2.47% 1.93% 0.65% 1.52% Standard Deviation 5.78% 6.15% 0.74% 1.00% Annual Returns 11.86% 9.59% 2.23% 7.93% December 1987 to December 2002 Source: SIRCA
Considerations Exchange Traded versus Over The Counter options Does active stock selection reconcile with a Buy Write? Strategy should provide targeted exposure and appropriate return ratio (combination of capital and income) Appropriate protection to the downside
Targeting income and exposure 100% 100% Exposure 50% 15% Income Exposure 50% Income Market Exposure 0% 4% Yield Premium Income Market Exposure 0% NET 6% Premium income targeted +4% Yield Premium Income Yield Out of the money At the money In the money Out of the money At the money In the money Strike Price Strike Price Source: Denning Pryce; Zurich Investments 9/11/2009 16
Executing an option strategy Step 1 Blue Chip Share Portfolio ASX 50 Leaders only Step 2 Generate income Step 3 Provide some protection & growth Active option management Results in sharemarket exposure, dividends and franking credits Results in additional income, dampened volatility and some capital growth Source: Denning Pryce; Zurich Investments 17
Generating income: BHP Call options $36.00 $0.00 $34.00 $0.50 $32.00 $30.00 $1.00 $1.50 $2.00 $28.00 $2.50 $26.00 $3.00 $24.00 $22.00 Sell Call at $2.62 The trade generates income as the option moves out of the money $3.50 $4.00 $4.50 $20.00 30/01/2009 10/02/2009 19/02/2009 02/03/2009 $5.00 BHP (LHS) BHP June 09 C $33.00 (Inverted RHS) Source: Bloomberg, Zurich Investments
Woolworths for income $29.00 $28.00 $27.00 $26.00 $26.63 Active target level 5/02/09 19/02/09 5/03/09 19/03/09 2/04/09 16/04/09 30/04/09 14/05/09 28/05/09 11/06/09 25/06/09 9/07/09 23/07/09 6/08/09 20/08/09 3/09009 17/09/09 1/10/09 15/10/09 29/10/09 12/11/09 26/11/09 $25.00 $24.00 $23.00 $22.00 Source: Bloomberg, Zurich Investments ex dividend date Target average down
CBA Put strategy $50.00 $47.50 $45.00 $42.50 $40.00 $37.50 $35.00 $32.50 $30.00 $27.50 $25.00 $22.50 $43.65 $42.00 $38.00 Absorb $2 5/02/09 19/02/09 5/03/09 19/03/09 2/04/09 16/04/09 30/04/09 14/05/09 28/05/09 11/06/09 25/06/09 9/07/09 23/07/09 6/08/09 20/08/09 3/09/09 17/09/09 1/10/09 15/10/09 29/10/09 12/11/09 26/11/09 Source: Bloomberg, Zurich Investments ex dividend date downside BUT! Protection over 10% share value for 2% cost for 100 days
Managing downside: Index Put options 4000 3900 3800 3700 3600 3500 3400 3300 $350.00 $300.00 $250.00 $200.00 $150.00 3200 The put provides protection, $100.00 Buy put 3100 increasing in value when the at $140 index falls 3000 $50.00 31/12/2008 21/01/2009 11/02/2009 4/03/2009 S&P/ASX 200 (LHS) March 2009 P3400 (RHS) Source: Bloomberg, Zurich Investments 21
Summary Use all the tools at your disposal Look beyond conventional strategies to help meet your clients objectives Options strategies can work in all market conditions to provide additional income and lower risk 22
Meeting the challenges with options 1 2 3 Generate income in all market conditions Provide some downside protection in falling markets Deliver conservative growth Zurich Investments Equity Income Fund
A strategy for all seasons S&P/ASX 200 All Australian Annualised Risk and Return for 2 years and 8 months ended June 2009 (before tax and before fees) Comparison with the Mercer Australian Shares Universe Annual Return (% pa) 7.0 3.5 0.0-3.5-7.0-10.5-14.0-17.5 Median 11.5 14.0 16.5 19.0 21.5 24.0 Annualised Standard Deviation (% pa) calculated monthly S&P/ASX 200 S&P/ASX 50 Equity Income Fund Targets a running yield of 10% pa Low volatility 1 year semi deviation 11.93% Cushion market falls 1 year excess return 14.4% 24 Source: Mercer, Zurich Investments
Thank you 25