28 May 2022
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How to get a 5% income return on your investments

Paul Rickard
27 May 2021

With big bank term deposit rates down to a paltry 0.40%, self-funded retirees are increasingly turning to riskier investment options to generate income. Others are drawing down on their capital, but this is not a strategy that can be employed indefinitely. And with the Reserve Bank maintaining that the cash rate is not going up until 2024 at the earliest, there is little relief in sight.

So here are some investment options that can generate a 5% income return. They are not riskless, because any investment promising a return over the “government guaranteed” rate of a term deposit involves risk. Further, the higher the promised return, usually the higher the risk.

Risk in this context means three things. Firstly, the potential loss of capital. Everyone gets this. Secondly, volatility in the price of the investment. Most people get this. Finally, with an income biased investment, the risk of underperformance – that is, the overall return (which includes income and growth) is lower than the market. The latter risk is not always well understood.

But they are diversified (to varying extents), meaning that single event exposures or “shock” losses are minimised. Here are 5 to consider, and one to avoid.

1. Vanguard Australian Shares High Yield ETF (VHY)

A low cost exchange traded fund from Vanguard, this fund tracks the FTSE Australian High Dividend Yield index. The latter is an index comprising stocks that have higher forecast dividends relative to other ASX listed companies. To achieve diversification, it restricts the exposure to any one industry to 40% and to any one company to 10%. Currently, there are 63 stocks in the index, with the top 3 weightings being BHP, Commonwealth Bank and Wesfarmers.

Compared to the S&P/ASX 200 Accumulation index (the broader industry benchmark), performance has been solid: 1 year to 30 April 39.8% pa vs 30.8% for the industry benchmark; 9.6% pa for 3 years vs 9.5% pa for the benchmark; and 8.8% pa for 5 years vs 10.3% pa for the benchmark. The management fee on the ETF is a low 0.25%.

Based on current analysts’ forecasts, VHY is expected to deliver a dividend yield of 4.3%. With franking credits (which for many investors will be refunded in full), it grosses up to 6.0%.

The Vanguard Australian Shares High Yield ETF trades on the ASX under code VHY.

2. Djerriwarrh Investments Limited (DJW)

Spun out of the JB Were Group more than 15 years ago and managed by the same team that runs Australian Foundation Investment Company, Djerriwarrh is one of the larger listed investment companies (LICs) trading on the ASX with $782m in funds. Interestingly, it is trading at around a 9.3% discount to its underlying NTA (net tangible asset value).

Djerriwarrh aims to pay a higher level of fully franked dividend than is available from the market and to provide capital growth over the medium term. It invests in a broad portfolio of largely “blue-chip” companies, and enhances the income return by writing call options over selected shares.

Including franking, Djerriwarrh is currently yielding 5.1%. This is based on a share price of $2.93. Over 21/22, this yield should rise marginally as companies resume paying higher dividends.

In an overall portfolio sense, Djerriwarrh has marginally underperformed compared to the benchmark S&P/ASX 200 in recent years, but is close to par over the long term (15 years).

3. Switzer Dividend Growth Fund (SWTZ) and Einvest Income Generator (EIGA)

These are two actively managed funds that are quoted on the ASX. Both invest in a diversified portfolio of 30 to 50 Australian companies targeting those with growing dividend streams. Switzer trades under the code SWTZ, while eInvest trades under EIGA.

The Switzer Dividend Growth (SWTZ) aims to provide investors with tax effective income and long term capital growth by investing in a core portfolio of blue-chip Australian shares. Income is paid quarterly, and franked to the maximum possible extent.

EIGA pays income monthly, targeting a 5% cash dividend yield and 2% in franking credits..

4. BetaShares Australian Dividend Harvester (HVST)

Another actively managed fund, it follows a rules based ‘dividend harvest strategy’ which seeks to maximise the exposure to dividend paying Australian shares. Typically, it buys shares to get access to their dividend and then sells them after they have gone ‘ex-dividend’. It also uses futures contracts to reduce market volatility.

While the income return has been attractive (a gross distribution yield of 8.5%), it has gone backwards in capital value. Over 5 years, the fund has returned (dividends plus capital loss) 1.01% pa, underperforming the benchmark index by a staggering 9.26% pa. Avoid.

5. NB Global Corporate Income Trust (NBI)

In the fixed interest area, this listed investment trust of $909m invests in a portfolio of high yield bonds of large, liquid global companies. The portfolio is diversified by industry, geography and issuer, and typically comprises bonds of 250 to 350 large liquid companies. They are at the lower end of the credit spectrum, with most being rated below “investment grade”. That said, the manager (the US domiciled Neuberger Berman) places a strong emphasis on capital preservation by focussing on credit quality, and says that defaults have been extremely rare.

Hedged back into Australian dollars, NBI targets a monthly distribution to unitholders of 4.5% pa. It recently announced that it expects to exceed this in FY21, with a final special distribution to be paid in July. It is also trading at a discount to its NTA (ASX unit price of $1.83 vs NTA of $2.04), meaning that its effective yield is now 5.0% pa.

6. Qualitas Real Estate Income Fund (QRI)

A $415m listed investment trust, Qualitas (QRI) invests in senior and mezzanine property loans secured by first and second mortgages. Focussing mainly on NSW and Victoria, the loans are used for investment, construction and to finance the purchase of land. 64% are residential, 26% commercial, 5% industrial and 5% are retail. The portfolio is reasonably concentrated with 35 loans.

The Qualitas Real Estate Income Fund delivered a net return to investors of 6.23% in FY20 and is on track to deliver a return of 6.1% pa in FY21. Distributions are paid monthly.  

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