Achieving stable income and portfolio resilience in an uncertain world

Produced in partnership with Betashares.

There is a growing number of ways to generate income, aside from working for it, which is good news for the nation’s 5.6 million baby boomers.

Over the next decade, around 2.5 million workers will transition from employment to retirement, joining around 4.5 million already retired Australians.

According to research by Investment Trends, the main goal of investors between age 55 and 64, and those over 65, is “building a sustainable income stream”, followed by “achieving a balance of capital growth and managing risk”.

In fact, across the board, investors are prioritising income and capital stability over capital growth, the only exception being those between age 18 and 34 who list maximising capital growth as their main goal, followed by building a sustainable income stream and then achieving a balance of capital growth and managing risk.  

“We’re seeing a clear gravitation towards investing for income,” Cameron Gleeson, senior investment specialist at Betashares, tells Professional Planner.

“For those approaching and entering retirement, they may need more cashflow because they’re scaling back on work but not yet drawing a pension.”

The need for income and stability has seen demand for income-orientated investment strategies explode in the past year.

Demographic changes only partially explain this trend, Gleeson says.

The other half of the story is that the Australian share market doesn’t offer the same amount of dividend income as it used to, dividends are lumpy, and bank hybrids are phasing out. On top of all that, capital gains tax reforms in the last federal budget curbed the advantages of growth assets.

The combination of these factors highlights the benefits of professionally managed, income-focused strategies, including income ETFs.

“Investors used to be able to get a pretty decent yield from just holding Australian shares and not thinking too deeply about it but that has changed,” Gleeson says.

“The yield of the ASX 200 is about 3.3 per cent, a little higher if you add franking credits, which is a lot less than it was five years ago. This has occurred because we’ve seen strong capital growth relative to underlying earnings, resulting in an erosion of cash yield paid to investors, which is a factor to consider when investing in equities.”

The “lumpiness” of income is another risk, he says, given listed companies usually only pay dividends a couple of times a year.

“If you’re trying to manage your cashflow throughout the year and you’re getting lumpy dividend payments, it’s not great,” Gleeson says.

Equity income ETFs can provide a diversified way to access dividend-paying companies.

Rather than relying on a small number of individual shares, an ETF pools the income generated across a broader portfolio. Many income-focused ETFs also make monthly distributions, potentially providing more frequent cash flow than directly holding companies that pay dividends once or twice a year.

Betashares Australian Shares High Yield ETF (ASX: HYLD) follows a process that is designed to avoid dividend traps. Companies are screened to reduce the risk of buying stocks with a high dividend yield but deteriorating fundamentals, which increases the risk of stock prices falling and future dividends being cut.

More than an afterthought

When it comes to building a multi-asset portfolio, the role of fixed income has traditionally been to provide diversification while delivering a resilient, sustainable income stream.

During Covid-19, when bond yields were exceptionally low, this view was challenged and bonds became an “afterthought” for many investors, Gleeson says.

However, investors have become more sophisticated in their approach to the asset class, tapping into various sources of fixed income, particularly as investment grade Australian bonds are now yielding up to 6 per cent or even more.

“The fact that investors can now get higher yields from fixed income than they can from Australian equities is pretty interesting,” Gleeson says.

“In the past, many investors gained exposure to bonds through an actively managed fund and didn’t put a lot of thought into it because the yields on offer weren’t that exciting but they’re now really thinking about the role fixed income can play in driving performance and helping achieve their overall objectives.”

The realisation that fixed income can have a meaningful impact on a portfolio’s performance and really move the dial for income-hungry investors has been a “really important shift” in the knowledge and understanding of investors, Gleeson says.

“Historically, when people thought about bonds the focus was on stability, defensiveness and diversification but today it’s all those things plus performance and income,” he says.

This shift has coincided with significant growth in the Australian corporate credit market, which has become one of the largest credit markets globally.

Non-government and corporate bonds exceed $1 trillion in total outstanding issuance, expanding the breadth, depth and resilience of Australia’s bond market.

“A lot of companies are looking to issue bonds in Australia and Australian investors are responding to this by looking beyond just senior bank bonds and big four bank hybrids,” Gleeson says.

“They can gain all sorts of fixed income exposures that can deliver higher yields.”

Universal appeal

As baby boomers age and inch closer to retirement, their allocation to bonds tends to increase. If the classic balanced portfolio during accumulation phase is 70/30 to growth and defensive assets, it doesn’t “quite invert” but it does shift in that direction, Gleeson says.

“Capital growth is still really important to retirees and pre-retirees, especially because people are living longer and can spend over 30 years in retirement, so they need some exposure to growth assets, but they definitely have a lower risk appetite and greater focus on income,” he says.

“We see a strong desire for income from all cohorts, not just retirees, and that is underpinning demand for income-orientated investment strategies.”