The biggest threat to your retirement income

Chris Meyer

Pinnacle Investment Management Limited

The demographic of Australian investor is getting older and with interest rates and bond yields falling to record lows there is a real thirst for income, particularly among retirees.

In search of this income, many investors are turning to the share market for dividend income, but few are looking beyond the ASX and a basket of just five shares, mainly banks.

This is true for investors choosing to self-manage their share portfolios and for those choosing other listed products, such as ETFs.

The Australian ‘concentration risk’ explained

Australian investors have the highest home country investment bias of any developed market in the world.

We believe this ongoing bias is one of the biggest threats facing Australian investors.

The chart below compares home country bias of investors in the US, The UK and Australia.

Australians have as much as 75% of their share portfolios in Australian shares while the ASX makes up only 3% of the size of global equity markets. This suggests an over-weighting of more than 70% to local shares, compared to just under 30% for North Americans and just over 40% for UK investors.

If you dig a little deeper into the stocks that make up the Australian red overweight bar, the results show a staggering over-weighting towards a handful of shares, mainly the banks, adding to this concentration risk.

 

The pie chart above shows the large weighting towards individual shares in self-managed super fund (SMSF) portfolios. The following bar chart indicates the four banks and BHP make up the top 5 holdings of those share portfolios.

While these bank stocks and particularly BHP have produced good yield for investors over the past few years, investors should not ignore the single sector risk they are taking.

For the banking sector, the Financial Services Royal Commission that came to an end earlier this year should have been a wake-up call. Furthermore, after an extraordinary year of dividends, BHP warned of significant economic headwinds in its recent annual results.

The dividend yield appeal of these stocks is understandably attractive but investors should remind themselves of the narrow sector and country risk they are taking when allocating such a large portion of their portfolio to these shares.  

The cause of this concentration risk - global investing myths

We believe there are three stereotypes which are stopping income investors diversifying into global equities. They are:

1. International equities are low dividend.

2. Currency hedging can dilute income.

3. Asset class selection is the biggest driver of returns.

First, let’s address the myth that international equities pay low dividends. The truth is, on average, international equity benchmarks are low dividend. However, high dividend paying securities exist which good investors and analysts should be able to identify.

The chart below demonstrates this. It compares income vs risk in Australian and global equities. You can see a greater amount of higher income, lower risk securities available in global equities than Australian equities. 

Regarding currency dilution, historically portfolio managers have not properly linked foreign exchange income with the underlying income in their portfolios. Good managers of portfolios containing global shares and bonds should be able to explicitly manage the FX income linked to the underlying securities and use the FIX income as an additional source of income over and above the interest earned off the bond portfolio and the dividends from the share portfolio. There are still a number of countries where interest rates are lower than in Australia (think Europe and Japan) where investors can earn a positive FX 'carry' when hedging into AUD.

Finally, it is generally correct that asset class selection can be the biggest driver of returns, but we argue that some listed securities can exhibit low volatility with high income and thus security selection, especially in equities, also matters. Combining good equity selection with bonds in one portfolio can provide investors with an additional benefit of lowering the risk of a portfolio when compared to a portfolio of equities only. 


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This communication was prepared by Pinnacle Investment Management Limited (ABN 66 109 659 109 AFSL 322140) (‘Pinnacle’). Past performance is for illustrative purposes only and is not indicative of future performance. Unless otherwise specified, all amounts are in Australian Dollars (AUD). This communication is for general information only and was prepared for multiple distribution. Whilst Pinnacle believe the information contained in this communication is reliable, no warranty is given as to its accuracy, reliability or completeness and persons relying on this information do so at their own risk. Subject to any liability which cannot be excluded under the relevant laws, Pinnacle disclaim all liability to any person relying on the information contained in this communication in respect of any loss or damage (including consequential loss or damage), however caused, which may be suffered or arise directly or indirectly in respect of such information. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. The information in this communication has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. The issuer is not licensed to provide financial product advice. Please consult your financial adviser before making a decision. Any opinions and forecasts reflect the judgment and assumptions of Pinnacle and its representatives on the basis of information at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this communication is prohibited without obtaining prior written permission from Pinnacle. Pinnacle and its associates may have interests in financial products and may receive fees from companies referred to during this communication.

Chris Meyer
Director
Pinnacle Investment Management Limited

Chris is part of the Pinnacle executive management team and responsible for driving the listed products business. Pinnacle’s mission is to establish, grow and sustain a diverse and complementary stable of world-class, specialist investment managers

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