Where to find higher yield

By Christine St Anne, Morningstar

As interest rates continue to fall, income-seeking investors need to explore higher-yielding alternatives to bank term deposits. They should look at a range of exchange-traded funds (ETFs), which invest across a number of asset classes, including equities, cash and bonds. There are attractive yield opportunities.

Equities

The equities asset class has high-dividend ETFs. These include iShares S&P/ASX High Dividend (ASX Code: IHD), SPDR MSCI Australia Select High Dividend Yield Fund (SYI), Russell High Dividend Australian Shares (RDV) and Vanguard Australian Shares High Yield (VHY).

Besides investing in the big four banks, these ETFs invest in a number of companies with strong dividend yields, including Metcash (MTS), Wesfarmers (WES) and Toll Holdings (TOL).

Morningstar fund research analyst, Alexander Prineas, says it is important that investors understand the characteristics behind these high-dividend ETFs. "The key point is to understand that the name of an ETF doesn't tell you everything," he says. "You need to understand the parameters of what the vehicle invests in."

For example, the IHD ETF limits its investment exposure to 4 per cent in a given company or 20 per cent in a given sector. "This forces a greater spread of investments and gives investors' greater diversification, but also pushes you down the market capitalisation [towards mid-cap companies]," Prineas says. This mid-cap tilt may make IHD more volatile than the market and its peers.

ETFs also differ according to the benchmarks they invest in.

For example, IHD tracks the S&P/ASX Dividend Opportunities Index, while VHY aims to replicate the FTSE ASFA Australia High Dividend Yield Index. High-dividend ETFs also have the benefit of franking credits.

ETF Consulting managing director, Tim Bradbury, says high-dividend ETFs offer investors a lot of choice, with SYI the standout. Its recent yield was more than 7.3 per cent, plus franking credits.

Apart from these high-dividend ETFs, investors can also take portfolio tilts towards relatively high-yielding ETFs, including financial ETFs and listed property ETFs.

ETFs including Aii S&P/ASX 200 Financials (FIN), Aii S&P/ASX 200 Financials x-A-REIT (FIX), BetaShares S&P/ASX 200 Financials Sector (QFN) and SPDR S&P/ASX 200 Financial EX-AREIT (OZF) invest in the major banks.

SPDR S&P/ASX 200 Listed Property (SLF) and Vanguard Australian Property Securities Index (VAP) invest in listed property securities, including Westfield Retail Trust (WRT), Mirvac Group (MGR) and Dexus Property Group (DXS).

Prineas says: "Banks are known for their attractive dividends and listed property companies are generating higher-than-average yields. These ETFs, which are concentrated in these two sectors, can give an income boost to an investment portfolio." Nevertheless, he says, investors need to be mindful that these ETFs are highly concentrated, given they are sector-specific.

Bradbury says sector ETFs give investors diversified exposure to financial equities with great yield and franking credits. However, he says investors also need to be mindful of some capital volatility.

Bonds

A number of fixed-income ETFs were launched in Australia this year. Fixed-income ETFs invest in a number of benchmarks that are exposed to the government and corporate bond markets.

Prineas says these fixed-income ETFs not only generate income through coupons to investors, but also play an important defensive role in a portfolio. "Bonds provide a counterweight to equities in a portfolio," he says. "Yields from government bonds may be lower than other yield-generating assets, but yields on these bonds offer greater certainty. They are definitely part of an income solution."

Bradbury says that with a running yield of 5.5 per cent on one particular fixed-income ETF, these products are very "retail friendly" and diversified. He says although yields are lower than some equities, fixed-income ETFs offer greater certainty during the holding period and are less volatile than equities.

Cash

Bradbury says cash rates will probably fall next month. As the Reserve Bank of Australia aims to energise the economy in the non-resource sectors, he sees even more rate cuts ahead. "When term deposits roll they will suffer a big drop in the future return," he says.

He says BetaShares Australian High Interest Cash ETF (AAA) gives a much better return than the cash management accounts.

"Some advisers are moving from the wrap account cash hub to buying AAA for clients," Bradbury says.

It is, of course, recommended that investors seek appropriate advice. Bradbury says the choices on offer will depend on a client's circumstances.

Morningstar's Prineas says it is also important that investors do not just focus on yield: sustainable income generation is not just about finding the most attractive yield opportunities, but also focusing on the total return of your portfolio.

About the author

Christine St. Anne is the online editor of Morningstar. She is also the author of A Super History, which explores the beginnings of Australia's compulsory superannuation industry.

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