Why you need an income engine

Chad Padowitz

Talaria Asset Management

Savers have long recognised the need to balance income and capital, but recently this has proven difficult as yields of all asset classes have fallen to very low levels. At the same time, capital returns have had a bull run.

In fact, the only decade where returns to capital in the S&P500 were as high as the last decade was the 1990s, and subsequently, the following decade’s return was entirely down to the income component.

Source: S&P, Bloomberg

So, since the GFC, it has been better to hold the capital than seek income but with prospective returns now low and interest rates at some point likely to rise, this is going to change.

In practical terms, income will be a greater component of total returns going forward regardless of the inflation outlook.

Looking at the breakdown below you can see that from 2001 to 2007, even though the index as a whole continued to grow sales (4.7% p.a.), the starting valuations were so high that the sales growth was offset by a valuation de-rate (-35% p/e) such that the shares only increased 1.5% p.a.

However, if you had the income component, you boosted your total return by over 50% p.a. during that 7-year period.  

Source: Bloomberg, Talaria
But the issue in equity markets is where to get such yield. Many equities with higher prospective yields are challenged with all or some of the following:
  • a trade-off between yield and growth, 
  • yields that are unsustainably high, 
  • high volatility, and 
  • greater sensitivity to risk-off events.

Finding a source of income that diversifies risk, does not result in markedly higher volatility, and changes the mix of savers’ returns to a greater balance of the capital and income components is important but not easy.

Not easy but possible - and in our case achieved through the implementation process, receiving a minimum 15% contracted rate of return per annum as a result of our commitment to buying a share we want to own. This flows through in the form of an income stream that is not dependent on a company’s ability or management’s desire to pay a dividend to shareholders.

In other words, an income engine.  

Not an existing Livewire subscriber?

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.

........
The information in this article is general information only and is not based on the objectives, financial situation or needs of any particular investor. In deciding whether to acquire, hold or dispose of the product you should obtain a copy of the current Product Disclosure Statement (PDS) for the Fund and consider whether the product is appropriate for you. Wholesale Units in the Talaria Global Equity Fund (the Fund) are issued by Australian Unity Funds Management Limited ABN 60 071 497 115, AFS Licence No. 234454. Talaria Asset Management Pty Ltd ABN 67 130 534 342, AFS Licence No, 333732 is the investment manager and distributor of the Fund. References to “we” means Talaria Asset Management Pty Ltd, the investment manager. A copy of the PDS is available at australianunity.com.au/wealth or by calling Australian Unity Wealth Investor Services team on 13 29 39. Investment decisions should not be made upon the basis of the Fund’s past performance or distribution rate, or any ratings given by a rating agency, since each of these can vary. In addition, ratings need to be understood in the context of the full report issued by the rating agency itself. The information provided in the document is current at the time of publication.

1 contributor mentioned

Chad Padowitz
Co-Chief Investment Officer
Talaria Asset Management

Chad is the Co-Chief Investment Officer and co-founder of Talaria Asset Management. He has more than 20 years’ experience in the financial services industry in the UK, South Africa and Australia. Talaria's investment strategy seeks to increase the...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.