How investors can achieve an after-tax dividend yield double that of the broader Australian share market while being exposed to a similar level of risk and at a lower cost.

You're watching the first night of the investment markets investor seminar.

Coming next, we have Mr. Jason Ho, Chief Investment Officer from Hamilton12.

The Hamilton12 Australian shares income fund aims to generate long-term after tax returns, including an annual gross dividend yield in excess of the benchmark.

The fund uses systematic evident-based approach that allocates the portfolio towards securities offering high franken dividend yield.

diversifying across industry sectors.

The fund's benchmark is the S&P ASX 200 Ranking Credit Adjusted Daily Total Return Index.

Jason has been widely recognised for his work on imputation credits.

His work on valuation has been relied upon by companies listed on the ASX and by Australian state and federal government agencies.

Prior to co-founding the company Hamilton 12, Jason was a director of the consulting firm Cardinal Economics and Finance, senior lecturer in finance at the University of Queensland, University of Michigan, and a board member of the CFA Society Detroit.

Welcome, Jason.

Thank you for having me.

So in this short presentation, I want to talk about the performance of Australian high yield portfolios.

At Hamilton 12, we have a particular high yield portfolio, which is invested in Australian shares paying high frank dividends.

But this presentation is about a more general approach to portfolio formation.

There's roughly $3.6 billion in ASX listed high yield exchange traded funds, and S&P reports that they have been growing at 21% per year for the past 10 years.

So clearly, there's an appetite amongst Australian investors for yield.

We know that's valuable for Australian residents amongst companies paying frank dividends, because even if they just hold the ASX 200,

they receive roughly a 1 to 1.5% boost on an after-tax basis from the benefit of those credits.

But what about the yield premium more generally?

Across countries and over time, researchers have documented that there is a long-term yield premium in terms of total pre-tax returns from holding high-yield investments.

But there is disagreement amongst researchers and portfolio managers as to why that long term yield premium exists.

Some researchers say, well, it's just risk.

High yield stocks are just riskier investments.

But other people say no, there's market frictions in place, which means that these high yield investments

are not efficiently priced.

That could happen because investors persistently have a growth bias in their investments.

It could happen because there's career concerns, or in other words, benchmark hugging amongst investors holding large investment portfolios.

High cash payouts are beneficial to investors because they constrain executives from making investments which increase the size of the company, but don't necessarily increase the value of the company.

And it could be the case that investors persistently understate the disciplined benefits on management of high dividend payouts.

So the questions we want to address are, what is the historical return premium from high yield portfolios?

Do fluctuations in economic conditions affect performance?

And what are some of the risks facing investors if they just try to rank stocks on the basis of high dividend yield?

And what we're going to see that in Australia, in terms of inflation-adjusted pre-tax returns, inclusive of the benefit of imputation credits, there's been a long-term return premium of 2.3% over the last 41 years.

And there are a couple of specific risks that we want to talk about.

There is below average market exposure from high yield portfolios.

And there is above average interest rate risk exposure.

We're going to see that returns vary over time and that's going to be consistent with any style based investment strategy.

And we're going to look at the potential 12 month forward looking yield of 8% inclusive of imputation credits from a well diversified high yield portfolio.

For this presentation, we didn't want to focus only on our portfolio.

We looked at four high dividend yield indices, which are available for investors to observe the data from in Australia.

We've got at the bottom of this table, information compiled by Professor Ken French from Dartmouth University, who is well regarded as looking at value based investment strategies over time.

And on his website, there's data available from 1983 to December 2022.

We've got our own index and we've got indices compiled by S&P and MSCI.

And we average the monthly return from those indices to strip out the idiosyncratic portfolio formation goals of each index to estimate a pure yield premium.

What you see on the chart

is the growth in the value of $100 over 41 years on an inflation adjusted basis, including the benefit of imputation credits.

And you see that over 40 years, four decades, you have a 2.3% inflation adjusted premium of which 1.2% comes from imputation benefits with the remaining 1.2 to 1.3% from a pure yield premium.

So in the long term, high yield investments beat the broader market.

So what we've seen is that on average, over 41 years, investors, if they had invested in high yield stocks within would have earned an inflation adjusted return, including imputation credits of 2.3% per year.

But unfortunately, investors don't get to live multiple lifetimes.

Investors holding stocks have seven to 10-year horizons typically, because it's a fairly risky investment.

So it would be important to know what is the potential for underperformance over a reasonable investment horizon of seven to 10 years.

So we broke down our 41-year period into six economic regimes.

And take a look at economic regime number five, and that runs from

July 2013 to January 2020, the onset of the COVID-19 pandemic.

And over that seven year period, the high yield average portfolio actually lost 2.3% relative to the broader market.

High yield stocks put on 7.9%, the broader market put on 10.2% in inflation adjusted terms.

So there was still a high return, but it was underperformance.

So investors really need strategies to try to mitigate the potential for that underperformance.

And one reason for the underperformance of this particular strategy over that particular regime is that remember, we're averaging four indices here to isolate yield and strip out idiosyncratic variation.

Well, three of those indices place a material weight on historical dividends in forming a high-yield portfolio, and they're not rebalanced very frequently.

And when you do that, you potentially fall into a dividend trap, assuming that past dividends are a good expectation for future dividends.

So you always want to be forward-looking.

In addition, you have to be cognizant of interest rate risk.

High yield portfolios have two offsetting risks.

On the plus side, they are somewhat defensive.

A 10% fall in the market is only associated with an 8.5% fall in the value of a high yield portfolio.

Or in statistical terms, high yield portfolios have low beta.

However, high yield portfolios, they trade a little bit like bonds.

For a 1% increase in the 10-year government bond yield, there is a minus 0.6% return to a high yield portfolio.

So below average market risk is offset by above average interest rate risk.

So let's think about risk mitigation.

There are two ways to form a portfolio that trades according to high yield.

The first approach is you rank all the stocks in your investment universe by dividend yield.

The second approach is to rank all the stocks in your investment universe by dividend yield, but within each industry.

Let's look at the characteristics of portfolios formed according to those two approaches and see what the current characteristics are at the end of June

2023.

First of all if you ranked stocks in the all-ordinaries index by their yield including credits irrespective of industry you would be looking at a 12-month prospective dividend yield including credits of 9.4%.

That's very high.

But on the downside, the one to two year prospective earnings growth is minus 9.1%.

And you would have 96% of your portfolio invested in three industries, basic materials, finance and energy.

You'd have no healthcare, consumer staples, technology, telcos or utilities.

So there is this very high interest industry exposure.

Alternatively, suppose you ranked stocks by yield within each industry.

If you did that, and again taking the top 25% of stocks by market capitalization, you would have a portfolio which had a 12-month forward-looking yield including credits of 8%, earnings per share growth approximately flat down 2.4% over forecast years one to two,

and only 54% of your portfolio in the top three industries are financials, basic materials and industrials.

You have 29% allocation to healthcare, consumer staples, technology and telecommunications.

So in conclusion, we know there's a yield premium.

Consistent with overseas evidence and consistent with a very long time series, over four decades, that premium in Australia has been 2.3% per year, of which you have roughly an equal split from imputation benefits and a pure yield premium.

There are two risks to be cognizant of.

There's below average beta, below average market risk, but above average interest rate risk.

And importantly, for risk management, you have to form portfolios on a forward-looking basis, so as not to be taken down the path of falling into a dividend trap, and importantly, be diversified across industries.

If you just rank by yield,

You will always be underweight healthcare.

You will always be underweight tech.

You will always be overweight, mature companies in the basic materials and financial sectors.

Thank you, Jason.

That's very insightful into the dividend and the yield.

We have some questions for you.

The first question is, in pursuing a high yield stretch and what is the most important pitfall investors should be aware of?

Well, the most important pitfall is over reliance on historical dividends.

You always want to be forward looking.

Take, for example, the big mining companies in Australia today.

They are at the very peak of their earnings cycle and analysts are factored in their forecasts.

So the more, always choose analyst forecasts and always be wary of the timeliness of analyst forecasts.

If you have access to very recent forecasts, rely upon those because remember, analysts are not updating their forecasts instantaneously.

There's lots of stale data even in analyst forecasts.

Right.

So when it comes to value-based strategies like dividend yield, they're sometimes described as a low turnover strategy.

Is that right?

Is that true?

I think that's a little bit misleading.

So there is this idea that value-based strategies like buying high yield or low PE stocks or low price to book stocks, you're only turning over about 10% of the portfolio a year.

But mathematically, it's just not true.

Suppose you're trying to beat the market by one to 2% on average or over an extended period of time.

And suppose that your strategy actually works.

So you do beat the market by one to 2%.

Are we saying that only you can get the one to 2% incremental return relative to the market by only turning over 10% of the portfolio a year?

Or in other words, is 90% of the portfolio just perennially going to beat the market?

It can't be the case that you're buying a cheap stock.

The price corrects to give you a return which beats the market, but then it's always cheap the next year and cheap again and a cheap again if you're always beating the market.

Well, thank you, Jason.

Great to see you today.

Take care.

Thank you so much.

Bye bye.