Why Dividend Shares are Eroding Your Capital

Dividend cuts and cancellations are coming thick and fast on the ASX's top dividend companies. FNArena Editor's Rudi Filapek-Vandyck explores how the hunt for dividend yield sets the portfolio up for poo long-term performance.

[00:00:06] Welcome back to Rudi Tuesday. We've had a lot of volatility in the markets and the man that we go to for the answers about what's happening. And where do we go? What's all this information and what does all this macro economic information lead to shares and performances? Is Rudy Filipic, Dick Van Dyke, editor in chief and Arena. And then he's back and I say, good morning. How are you, Rudy? [00:00:26][19.8]

[00:00:27] I'm trying. Christopher, thank you. And I will do my best to answer your questions and enlighten. Disparage. [00:00:32][5.3]

[00:00:34] We'll lighten the spirits, is it difficult in this current climate? But the market has been rallying. Although reading your weekly report this week saying that investors is stuck hunting for yield again, but dividends are looking bleak, the outlook is quite bad. Some are being tut, tut and some without any sort of change or guidance. So the difficult question now is how do we get yield and is a good or smart way to do it? [00:01:02][27.5]

[00:01:03] Yes, I think it's probably fair to say that Australian investors are extremely hard hit this year. I know that many on social media in particular and in general commentary, the market bulls are out in full force because we've had this strong rally from the March lows. And it will appear for the time being at least, that a lot of the pain we suffered earlier has not been long forgotten about. And we can look forward again. But in the background, there's a lot of pain and a lot of damage being done. In particular, I would argue to Australian investors portfolios, because for multiple reasons, in particular in Australia, investors have used the sharemarket to to obtain what they regarded as a regular and reliable income. And I've been saying this for for quite a while. And it's typical for the sharemarket and for for our human behavior as well in that some things don't matter unless they do end up until they do. And what if what if what we've seen this year, what we've experienced this year is that investors who actually have ignored the fact that if you buy a high yielding stock in the sharemarket, that because the general dynamic has changed in financial markets. So if you're now buying a stock and let's say at 5 or 6 percent yields, then you're actually buying a high risk equity. That didn't always used to be the case. In times when we have higher bond yields and higher interest rates and higher inflation rates than 5 or 6 percent is not necessarily high risk in those days, you would have to go to 7 percent or so. But in the current context, 5 or 6 percent essentially translates into higher risks now for a lot of people. They would they they either haven't been told this or they weren't aware of this or they weren't aware of it, but they ignored it nevertheless, because they want that income. And then obviously then comes a time when when that is coming, coming back to bite them in the arse. And last year, the second half of last year was one of those periods when quite a number of companies started cutting their dividends last year. The optimists thought, well, that's a one off. We we've had that. Now we can look forward again and then come 2020 comes along. And it actually that was just the warm up act. I mean, this year is going to be absolute carnage. [00:03:51][168.3]

[00:03:53] Talking just to jump in there for a second, talking names that investors know, which is the big four banks and Telstra. They've got other names with pointing the finger at me. [00:04:01][8.5]

[00:04:03] Well, dividend cuts this year are coming briskly from every corner. It's coming from the left, from the right, from the middle, from the center, from below and from above. Almost every day now we we see now companies at the very least reducing dividends, if not deferring, delaying or completely cutting, cutting it for the time being. So this year is not going to be a good year for investors who will have a strategy which is built around getting income from the sharemarket. And what I will I try to explain this week in my writing is that I mean, I'm not trying to blame the moment you think, but I'm trying to explain to them that there are better ways of doing it, and that is by not focusing on the yield that you're getting right now. I think investors in general, in particular, that type of investor is constantly forgetting that the sharemarket at the end today is all about growth. And you can. It's very dangerous to use the sharemarket for other purposes than to buy companies that have growth under the belt. Now, how do you how do you incorporate that in a strategy that when you need income? Well well, I tried to explain to people is that there's two ways of getting income from the sharemarket. One is a company pays you a dividend. The other way is, is that you sell some shares which you have purchased at a lower level, and that is often not taken into account for investors, so why? I think that the best strategy is to combine both you combine growth and income and you combine income with growth. What that means is that you are far less susceptible in your strategies to a two to a capital erosion. And a lot of people have underestimated the fact that if a stock only has dividends to offer, it's most likely to end below your purchase price over time. And we've seen that with the likes of Telstra. You've seen that with all the major banks that have been eroding the capital base over the over the past few years. And we've we've mentioned this a couple of times in previous editions, but I want the portfolio. And that portfolio is basically based around the principle that I have tried to expand this week. Basically, what I've done is as follows I try to construct a portfolio that has on average in the portfolio around 3 percent in yield. Forward looking 3 percent is not enough for most people. They want 6 and then maybe even franking on top. But what you do, in my view, is that the portfolio obviously generates a return and let's say the portfolio generates 7 percent on a given year or so. Now you had 3 percent out of dividends, then you just sell an extra 3 or 4 percent out of the 7 percent that you made to make up for the fact that your portfolio in the initial phase is not generating enough return just yet in terms of cash payouts because your portfolio grows. In a few years time, it will come to 4 percent to 5 percent and it will have 6 percent yield. And even because there's growth in the portfolio, it even goes beyond that. And at one stage, she might have to take out less or have an extra holiday or whatever. But that principle, which I which are put in place with your weather portfolio over the past five years, would have worked. And at the very least, it would have safeguarded people's capital from eroding while you are taking your income out of your share portfolio. There are numerous other advantages with that approach, because if you have strong, solid growing companies in your portfolio, then you by definition you have less risk in your portfolio in particular. If if mean depends on the types of companies as well, of course. But if you have solid industrials in there, then you carry less risk. And when when too than 20 comes along, you're not necessarily sitting on the stock that Hoff's in price and then cuts its dividends. So there's multiple ways of going around just theme and people don't have to exactly copy the likes, the stocks that I have in portfolio. But in general terms, I believe that you should not be focused on every single stock in your portfolio. Bang you 5 or six per cent plus franking. You should take a more holistic, all encompassing full portfolio view. And if that portfolio grows in value over time, gives you some income and you can you can sell a few shares. In the meantime, then you are safeguarding your your capital. You are being a much better investor. You are carrying less risk and you are much more resistant to when when bad news comes around. And I'm glad that I've been able to put that in practice over the past five years. [00:09:36][333.5]

[00:09:38] I'd say by way of example, if we compare your wealth portfolio that you work with at the moment and look at that over the last five years, this is very common. Companies that are sitting inside a lot of self-directed investors portfolios, the banks and Telstra. They've seen a lot of capital deterioration in the last five years. If we just zero in into this 2020 aspect of the portfolio, how is that portfolio compared to the overall market in the drawdown and then the rally? So how's that portfolio looking now compared to the market in recent times? [00:10:12][34.4]

[00:10:13] Yeah, well, one of the things I find stands out from from the portfolio over the past five years is that you that you will see that in the down years of the sharemarket, the portfolio is actually not not not down as much of this week. I've just lined up to put the performances for the portfolio and you will find that in 2015 the portfolio was positive and the sharemarket as a whole was negative in twenty eighteen. The share market as a whole was negative and the portfolio was too positive. And you will find that in the booming times the portfolio can't keep up with the index. Well, underperforms a little bit. That's what happened in 2016, for example. That's what happened last year. But it wasn't by by a lot, but it was just we just before it can keep up with with the likes of BHP and Rio rallying very hot. But in general terms, if you spread out over five years, the performer R1 has outperformed the index and has definitely outperforms all the portfolios that were centered around. I need income, so I stack up on banks. I have all the insurance companies in there. I have those small industrial stocks in there, the retail wheats, you name it. And those stocks essentially have lost people money and this year have been forced to to reduce or cut their dividends. And then, of course, you run into the fact that you you you have not been doing the right thing. And somehow this year the punishment has fallen. But. It's a wise lesson for investors, and I hope they draw the wide lesson from this. It's okay to have a few banks in your portfolio. If if you will not raise the overall payout level of what you have in your portfolio. But it shouldn't be excluded that you also have a CSL, HASMET, a cochlear technology one, etc. because those stocks will guarantee you that your capital as a whole doesn't go backwards. [00:12:27][134.1]

[00:12:29] So that's a critical point for the portfolio, construction needs now even lower for longer environment. That's ahead of us. Just quickly looking at the rally that we've got in front of us. I know you've looked at and read some reports about the economic. Macro economic data that's coming out, this relief rally. Is it sustainable? Or do we need other parts of the financial markets to participate before we really get conviction that this is a full recovery? [00:12:54][25.0]

[00:12:55] Well, that's Obasi, the 44 million dollar question or whatever number you want to put on this one. I mean, I am with a large number of market ops observers and experts who are quite surprised by how far this rally has gone. On my observation, what what investors have done, if they've their first bought up all the safe and reliable, sustainable, high quality stocks, they've taken the index pretty much to this point. And then the market started rotating into the laggards ended and the cheaper stocks and the cyclicals and more vulnerable stocks. And that's an attempt now to get this index higher. I find a bit on the early side, but OK, that's that's that's my view is not necessarily correct because we're talking animal spirits here. And when share prices go up, there's nothing as enticing. And that makes it as attractive as putting your money in the share market as when share prices keep on going up. But one of the examples I pointed out this week is that there are sometimes other signals investors can use to determine whether there's more at hand and simply equity investors going a little bit ahead of themselves. And one of the ways of doing that is looking at other market signals that might indicate whether the situation out there is indeed improving to a point where we might be able to leave this bear market behind us and move into a new bull market. And one of the experts I relied on this week, which I quoted, is a long view economics. And they basically noted that all the other market signals that usually back up the equity market are rallying as far as it has into a new bull market, have not responded at all. We're talking the spread on the high yield corporate bonds in the US. We're talking 10 year bonds, government bonds in general. There was a mentioning of a emerging markets currency index, et cetera, et cetera. So at the moment, it's only the equity markets doing their thing and it's not backed up by by any of the other market signals. Now. It's obviously not impossible that the other market signals might follow. But I do think that maybe the odds are more in favor of the equity markets at some point has to retreat back or at the very least go sideways because it's at there has been a little bit early in that in that context. By the way, I I observed this morning and I pointed this out on social media as well, that I know the share market moves up every day and goes down the next one and it has a lot of movement going on. But essentially, the market hasn't moved here for four, three weeks now since mid of April. And that's something maybe also to to keep in mind that mean we're trying to achieve a lot here, but we're actually treading water a little bit. And that's typical for a market that has has had a big rally and now has this big question mark in front of it. And what next? Of course. I mean, we can we can have we can have news about the vaccine next week or the week off. It's possible. I don't think it's plausible. And I think the best case scenario probably from here is that we will we will, we will in broad lines, I think will move sideways. [00:16:41][225.9]

[00:16:43] And that's what could be ahead of us some time yet. But the way to say through that is, as you mentioned, work with the growth companies and the ones that will be providing better capital preservation or gross into the portfolio. Not just now, but for the years ahead. Thank you very much. My pleasure, sir. [00:16:43][0.0]

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