Investors need to change the way they think about generating income from their equity investments and be prepared to draw on capital gains as well as dividend payments.
Two of Australian’s most successful equity managers, Platinum Asset Management chief executive Andrew Clifford and Magellan Financial Group chair Hamish Douglass, agrees that investors have to accept that cashing in some capital growth is part of the equity income equation.
Speaking at a recent Morningstar conference, they talked about the impact of low interest rates on investment returns, particularly income returns.
Douglass says: “We have to distinguish between equities and fixed income. If you want higher income from fixed income you have to go up the risk spectrum and invest in higher risk credit. I would caution people on that.
“Fixed income assets that trade at high spreads do that because they have very high losses when the cycle turns.
“In the equity market, I don’t think it really matters whether you are getting a return as income or capital.
“We have tried to address that issue at Magellan. Our global fund pays out a constant 4 per cent a year, and we index it for the growth over time, so that you are getting a 4 per cent return on the growing capital. We want to make it easy for people.
“Part of that is income and part of it is capital gain being distributed. If your asset is returning 8 per cent it doesn’t really matter is you are getting 2 per cent in income and 6 per cent in capital growth, or 5 per cent in income and 3 per cent in capital growth.
“If you are getting growth it does not matter.”
Clifford says: “You do have to think about cashing in some capital growth each year because that is the way stocks in many parts of the world are giving you income. In the equity world some of it is about capital appreciation.
“In a market like the US, it is very tax efficient to use stock buybacks. This is a very efficient way of distributing income.
“The best yielding stocks at the moment will be some of the European banks and some of the cyclical mining stocks.
Douglass says Australia investors can’t ignore the value of franking credits they get with dividends paid on the local shares. But he argues that investors will get better opportunities in global equities.
“We see opportunity in the transition of the world’s computing power to the cloud – to very large data centres. It is a very large market.
“We don’t have big cloud computer companies in Australia to invest in. Technology is a very big part of what is going on today and wit will be a very big part of what happens for the next 20 years.
“Getting exposure to the Chinese consumer is another big theme. There is very little exposure to that in Australia.”