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A short-term strategy using instalments to generate income

Whilst most instalments suit medium to long-term investors, some can provide you with short term trading opportunities to maximise your income stream. Short dated instalments are ideal for a strategy called Dividend Yield Play (DYP).  This goal of this strategy is to maximise your dividend income.

Instalments allow you to buy shares, and other securities, for a fraction of the current share price whilst receiving the benefits of capital growth, dividends and franking credits. Most instalments suit medium to long-term investors.  However some instalments can provide you with short term trading opportunities to maximise your income stream. Short dated instalments are ideal for a strategy called Dividend Yield Play (DYP).  This goal of this strategy is to maximise your dividend income.

How does the Dividend Yield Play (DYP) Strategy work?
This strategy allows you to generate income from dividend payments by holding an instalment through the dividend period.  Because you are outlaying less capital per share exposure, you can potentially accelerate the dividend return or yield.

An active trader can also benefit from successive 'dividend yield plays'. The aim of the DYP is to generate a regular dividend income stream throughout the year by buying instalments prior to the ex-dividend date and then selling those instalments some time later.  Generally this must be 45 days to be entitled to the franking credits. This process is then repeated by reinvesting the capital into the next dividend opportunity.

ASX Structured Products team is currently conducting a Dividend Yield Play portfolio study that shows two portfolios set up to compare the performance of trading a share portfolio for dividends against the performance of trading an instalment portfolio for dividends.  To keep up to date with returns on each portfolio visit the ASX website

The table below shows a selection of blue chip companies that have gone ex-dividend over the past twelve months:

February CBA
March TLS
April CML
May ANZ
June NAB
July
August CBA
September TLS
October CML
November ANZ, NAB

Dividend Yield Play Case Study

Current Situation
Kate and James are investors looking for ways to increase their income stream.  With $10,000 to invest, Kate and James want to maximise their returns through gearing, however they prefer a more conservative level of gearing (50- 65%).

Investment Strategy
In order to maximise Kate and James’ dividend return, their adviser recommends using instalments in a strategy called Dividend Yield Play (DYP).  This will allow them to increase their exposure to the share for the same capital investment while receiving the full dividends and franking credits.  To illustrate how this strategy works, the adviser provides an historical example using $10,000.  

In this example Wesfarmers (WES) announces that they will pay a 92 cent fully franked dividend on 10 August 2004 with an ex-dividend date of 16 August 2004.
To compare instalments against shares, a regular geared instalment is selected expiring in 3 months:

  • WESIWG - a regular geared instalment (64% gearing level)

The table below shows that while each instalment and share receives the same dividend payment, the returns in percentage terms are greater for instalments.  For the same capital outlay you can purchase more instalments compared to shares, and therefore receive a greater amount of dividends. 

WES Shares WES Instalment(Loan - $19.00)
Number of shares/instalments 337 968
Buy price $29.65 $10.32
Sell price (45 days later)* $31.50 $12.79
Trading Profit $623.45  $2,390.96
Total Dividends Received $310.00 $890.00
Dividend Yield (%) - not annualised 3.1%  8.9%
Total Profit $933.45  $3,280.96
Percentage return on investment - not annualised 9.3%  32.8%

To minimise the exposure to share price risk the instalment should be purchased after the underlying share has announced their profit results (including the dividend).

Outcome
Comparing this in dollar terms, Kate and James are able to purchase almost double the number of instalments to shares, increasing the income stream on the original investment. By executing consecutive dividend yield plays they can potentially generate an ongoing income stream. It is important to be aware that the success of this strategy is largely dependant on the ongoing performance of the underlying share after the company has paid the dividend.

Main benefits:

  1. Increased dividend income stream and enhanced yield
  2. A small positive move in the share leads to a higher percentage profit on the instalment
  3. Instalments require less capital invested to receive the same dividend income.  Alternatively, you can generate more income from instalments than from the same capital investment in shares

Main risks:

  1. The share price may continue to fall in the period immediately after the ex-dividend date (e.g. a fundamental change in the performance of the company)
  2. A small negative move in the share leads to a higher percentage loss on the instalment. This is because instalments are a leveraged investment
  3. The more highly geared the instalment the more significant the funding costs

© All rights reserved 2004. This material is educational and it is not intended to constitute financial advice.

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