How income rescued Aussie shares from a ‘lost decade’
Some commentators have bemoaned the lack of returns from the Australian equities market in the past ten years, calling it the “lost decade”.
We think that is a harsh portrayal of the past decade of returns from the Australian equity market. Whilst it is true that Australian share prices have largely treaded water over the past 10 years, and in the case of the mining bellwether, BHP, have actually gone backwards, this ignores the powerful role that income has played in generating returns over that period. Investors have not come away completely unrewarded. Once you include the dividend income derived from share investments, the returns were actually quite solid, particularly for pension phase investors.
The danger is that many Australians are heading into retirement and moving to pension phase. If they buy into this bleak story told about Aussie equities, it could give them the wrong picture about the role of equities in delivering not just returns, but income streams, particularly in retirement.
Income rescued stocks in 2015
You might remember that the Australian market finished 2015 on a positive note with that late December rally. It was a nice Christmas present after a tough year.
Despite the rally, there is no doubt returns for 2015 were subdued: in price terms the S&P200 index fell 2.1%.
But when dividends are counted, the index actually limped to 2.6% return for 2015. Franking credits further boosted returns for low-tax investors, with pension phase superannuation investors managing a 4.2% return.
Investors are now able to easily factor in the impact of franking credits, because in 2015 S&P/ASX launched a new series of after tax performance indices. The 4.2% return is the return calculated on the new S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt). This might sound a mouthful, but essentially it calculates the return a pension phase superannuation investor or a domestic charity would earn had they held an investment in the S&P/ASX200 Index.
Basically, income rescued Australian stocks from a really bad year in 2015.
And again over the past 10 years
We can see this same dynamic, where income delivers the bulk of returns and offsets poor or negative capital gains, playing out over the last decade too.
The late December rally helped push the Australian share market to about a 10% price rise over the 10 years to 2015, or an annual price return of just 1% p.a.
This is substantially less than the average inflation rate over that time of 2.7% p.a. But, again, this ignores income.
The accumulated return on the S&P200 over the past 10 years, including cash dividends, was 5.6% p.a.
For tax-exempt investors who get full refunds of franking credits, the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt) earned 7.2% p.a. over the same 10-year period.
Now, 7.2% is not a stellar return, but it was substantially better than the average 4.2% cash rate over the past 10 years, and handsomely ahead of the average inflation rate of 2.7% p.a.
For some reason many investors tend to forget the dividends, but as it turns out the vast majority of returns over the past decade came from dividends. For a pension phase or charity investor, some 85% of the total returns from Australian equities came as income over the past decade, with franking credits alone accounting for some 22% of the total return.
A handy income yield still on offer
What is the outlook for returns going forward? Interestingly, we think a poor outlook for commodities no longer necessarily means a poor outlook for Australian shares.
2016 hasn’t got off to a great start, with equity markets falling around the world, and commodities, particularly oil, continued their downward spiral. And we don’t see any quick bounce back in commodity prices any time soon.
The current falls in commodities like oil, gas and iron ore have been due to significant expansions in supply over the past decade. Iron ore production has been massively increased in Australia by the likes of BHP, RIO and Fortescue.
Oil and gas production has been boosted by massive investments in oil sands in Canada, oil shale in the US, LNG around the world and CS LNG in Queensland, whilst the recent lifting of UN bans on Iranian oil exports further adds to supply.
These supply overhangs may take years to reduce, so we don’t see any quick rebound in resources stocks. A bad resources outlook usually means a bad outlook for Australian shares.
But things have changed.
Back in the middle of 2008, resources accounted for approximately 36% of the S&P/ASX 200 by value, with BHP alone accounting for 14% or approximately 1/7 of the entire index value. Today, resources account for just approximately 11% of the same index, and BHP is a shadow of its former self representing just roughly 3.6% of the index.
We still predict the Australian share market delivering a handy 6% p.a. income yield factoring into account franking credits. That yield compares favourably to the yield available on more traditional income investments such as cash, term deposits and bonds, given the Australian overnight cash rate currently sits at an historic low of just 2%.
No lost decade
So whilst shares haven’t provided much capital growth over the past 10 years, they have provided considerable income, particularly for investors like pension phase investors and charities who get full refunds of franking credits.
And given that the past 10 years of returns included one of the worst periods of the Australian equity market of all time (the GFC), a 7.2% p.a. return for tax exempt investors actually turned out to be not quite so bad. Perhaps a poor decade, a rollercoaster decade, but hardly a lost decade.
About the author
Don has over twenty years’ investment management experience and founded Plato Investment Management Limited in 2006. Don has written a number of white papers on after-tax investing and has spoken at many conferences and seminars on this subject.
Prior to Plato Don was Head of Active Equities, Asia Pacific and a member of the global Senior Management Group at State Street Global Advisors, responsible for over $10B in active and enhanced equity investments.
Don was a Lecturer in Finance at the University of Queensland (UQ) for six years, and was a Visiting Assistant Professor at the University of Michigan Business School. Don has a PhD in Finance and a Bachelor of Commerce with First Class Honours from UQ, and a University Medal.
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