Views at a Glance / Income Report; Using ETFs for Income + the new CBA hybrid

By Market Matters 07 March 18

Income Report; Using ETFs for Income + the new CBA hybrid

Market Matters Income Update 7th March 2018

A weaker than expected open to trade this morning and as I tap away, the index is getting whacked following news that Trumps economic adviser Gary Cohn has resigned . Wilbur Ross, the Commerce Secretary who apparently recommended the Trade Tariffs and Cohn had a pretty heated disagreement and Cohn has resigned as a result. It seems the belief is that Cohn’s exit gives Trump full reign to target those countries which run trade imbalances with the US. In essence,  Cohn was the offset, he was a free trade man, so the market is concerned at how aggressive Trump will now be with Cohn out of the mix. US Futures are trading down -1.3% and the Australian market has followed the weakness .

Another Trump related sell off as the market was starting to look good yesterday…

All sectors in the Red today on the ASX at 11.15am

In terms of the MM Income Portfolio over the week,  the portfolio was down by -0.28% in a market that was weak overall. Since inception (5/7/17) the portfolio has gained 6.89%% tracking nicely above the market and above the portfolios benchmark. As always, to view all recent activity on both MM Portfolios - click here - or navigate to the RECENT ACTIVITY screen on the website.   

Using ETFs for Income

There are very few ‘holy grails’ in terms of investment products around the markets and ETFs are certainly not one of them. They won’t make you rich nor will they make you poor, they are simply a vehicle to enact a specific market view. We touched on negatively correlated ETFs yesterday morning which are actually fairly simple in their structure, using futures contracts to offer a ‘short exposure’. Stock ETFs, particularly yield focussed ETFs are more complicated and require some more in depth thinking / analysis.   

Generally speaking most ETFs are very simple / straight forward in their structure, are designed only to track an index or theme in a low cost way, while some are more complex and have a specific strategy behind them and are therefore more like managed funds. In short, we like the simpler ones and would avoid the more complex ‘strategies’ that are finding their way into the ETF world.

Below is a list of income focussed equity ETFs as a starting point, but more work is certainly required.


Source; Market Index

For instance, the first ETF on the list (the ZYAU) is reasonably new having commenced in 2015, has $48m invested so is reasonably small, average daily turnover of 24k units, however in terms of liquidity the number to look at is the implied liquidity based on the underlying holdings of the ETF, in this case,  the implied liquidity is $78m per day as the shares underpinning it are liquid.   

As an investor looking at that ETF for income it might come as a surprise that they hold 10% of the fund in South32 (S32), a big position in a volatile company with no consensus data on the expected dividend through Bloomberg.

ZYAU

That holding has been a major contributor to the funds ‘outperformance’ this financial year with the ETF producing an annual equivalent return of 12.09%, however given almost 50% of the ETF is held within the 5 top stocks, this is clearly a concentrated fund, something which is not obvious when glancing at its description. Concentration is not necessarily a negative and in this instance, over that time frame it has underpinned very good performance so kudos where it’s due, however concentration will create volatility in returns and ultimately a higher risk product than a  larger more diversified fund.

Performance of funds listed above this financial year to date – look at the Annual Eq (equivalent) column at the end

The other ETF that stands out for strong performance this financial year to date is the Russell Australian Responsible Investment ETF on an annualised equivalent of 10.13%. This has $68m invested, average volume of 6k units per day and an implied liquidity of $6.1m. In this instance, the funds holds a position in Spotless (SPO) which is illiquid and that reduces the implied liquidity number. The issue / question from our perspective is, what is an investor actually getting, what ‘value add’ is there in a fund like this given they simply hold the 4 banks within their top 5 holdings and rebalance twice a year? After all, they charge 0.45% pa for the privilege.  

The 3 most popular Income ETFs are the Vanguard (VHY) which has $1bn invested, the Betashares (YMAX) which has $395m invested and the iShares (IHD) with $260m invested. All of these have good liquidity with the Betashares YMAX on track to book the best performance this year. That fund is currently up 5.94% financial year to date, has an average yield of 6.77% and a P/E of 15.72, or in other words, metrics that are very much in line with the overall market. To us, these are hardly exciting metrics for  the 0.59% fee being charged, while if we look at the longer term performance, it has trailed it’s benchmark by an aggregate of 9.88% since inception in 2013.

The best performer in the income space over 5 years has actually been the Vanguard Fund (VHY) which has outperformed the accumulation index  by ~2% annually before fees, and this is the ‘cheapest’ of all the funds with a 0.25% annual fee. It’s also the most liquid.

In terms of analysing its holdings, it’s a fairly simple beast and just tracks it’s benchmark. One aspect that does catch our eye though is that it’s expensive from an earnings perspective trading on a PE of 17x and it holds ‘yield’ investments, two themes that will have clear headwinds in an environment of rising interest rates.  

In terms of the underperformers, the Betashares Harvester sticks out for all the wrong reasons and this is a fund we’ve covered numerous times in the past. Suffice to say we don’t like it, and have no interest investing in it.

We have not discussed the UBS IQ Morningstar ETF as it only has $24m invested, while the VanEck Vectors ETF has just $3.83m.

Conclusion (s)

While the growth in ETFs can’t be denied, we find it hard to get excited about equity income ETFs in aggregate.
In our view, ETFs are best utilised for specific themes rather than gaining (for example) broad income exposure
Cheap international exposure is another area where ETFs can be beneficial and we’ll cover those in future reports.  

CBA Hybrid Deal

Today CBA released a new Hybrid Security that, on a relative basis looks more attractive than the recent Westpac Hybrid which lists on the 14th March. Two important points. The Westpac deal was priced at 3.20% over the bank bill rate with 7.5 years to first call, while the CBA deal will likely be priced at 3.40% over with a similar duration. It means the Westpac deal will likely open below the $100 face value, by about ~1% all things being equal. Obviously sitting with the benefit of hindsight,  $1 to invest today would oscillate into the CBA deal over and above the WBC note, however in our view both on a relative basis still look attractive, particularly given there is likely to be very little supply for the remainder of the year.   

Details of the CBA deal…from Bond Adviser below. We have the CBA Treasurer in this afternoon to run through it. Unlikely that we will learn a lot given the deal has been priced and the structure is the same as Basel III Tier 1 securities issued post 2013. The only other difference to the recent Westpac Note is this is a new money deal only – not a roll from an existing security. They will likely print something like $1.20bn in our view also long as demand is there, which would be all new money.

All in all, this is a fair value deal given where the market is now trading and we are likely to add this security to the MM Income Portfolio .

To bid for a priority allocation

Through Shaw and Partners, MM subscribers can bid for a priority allocation within the bookbuild process. For more information please email; [email protected] or call (02) 9238 1561

Have a great day

James & the Market Matters Team

Disclosure

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