Drop in investment income

Nine months in and, so far, 2020 has been an extraordinary year. Back in January we were discussing the fact that share markets were close to all-time highs. In February we were suggesting that market volatility was on the horizon, and by March, Coronavirus was having a dramatic impact on the global market. We have continued to monitor market activity and have published a number of updates over the months – March, April, June and September.

Many investors rely on income from their investments in the form of interest, distributions and dividends to fund some or all of the withdrawals made from portfolios and are understandably concerned about the potential effects of COVID on this income. Today, we look at how income from investments has been impacted and the income expectations for FY21.

Graeme Quinlan, Senior Adviser and head of the First Financial investment committee, and Andrew Doherty, our direct equities consultant, provide insight into what might lie ahead and how our unique Investment Philosophy helps to ensure there is enough cash available for portfolio withdrawals, even as income from investments may reduce.

Company reporting season

Company reporting season

The FY20 company reporting season was under intense scrutiny this year as investors waited for information about the impact of COVID-19 on company fundamentals. Andrew explains,

“The August 2020 company reporting season reflected the initial stages of the pandemic economic shock. Sharp declines in earnings were met by dividend cuts and capital raisings to boost balance sheets. Management teams are having trouble providing earnings guidance.”

Earnings expectations were significantly reduced in the lead up to the end of the financial year as the economic outlook was continually evolving. However, overall FY20 reporting was actually better than expected, especially for particular sectors.

For example, within the consumer discretionary sector there were earnings upgrades driven by a strong increase in online sales as more people settled into their working from home routine. Resource companies also experienced earnings upgrades and continue to remain resilient.

Andrew outlines how the results varied across industries:

“Some of the hardest hit sectors include energy producers, due to the collapse in commodity prices and demand, and building materials suppliers, due to lower housing activity. Banks, which many investors turn to for income generation, cut payout ratios in response to weaker earnings and regulator guidance to add ballast to capital ratios.”

The positive news is that not all areas are struggling. Andrew continues,

“Sectors delivering the strongest earnings performance include healthcare due to the essential services being provided, technology due to structural growth in existing and new markets, supermarket retailers benefiting from the stay at home period, and miners enjoying elevated commodity prices and the return of China’s demand.”

Looking to FY21, this is where many companies have held back from offering earnings guidance. Economic uncertainty looms as the pandemic continues to affect markets around the globe, and it is difficult for organisations to set earnings guidance confidently.

Our Investment Philosophy

Our Investment Philosophy

Citi Group estimates a drop in dividends of about 25% for FY21, in line with our investment committee’s forecasts. This will result in a reduction of market yield from 4% to 3%, excluding franking credits, and while this is significantly lower than average, we know that our Investment Philosophy is designed to endure fluctuations in income.

Graeme explains,

“Our philosophy is built for uncertainty. Our three-bucket structure is robust enough to withstand market volatility while still delivering income.

By maintaining 12 months’ income in the cash bucket and the next two to four years income in the low-risk second bucket, there should be no need to access funds from the growth investment bucket.

Portfolio income is in addition to these amounts filling up the first bucket. So, if portfolio income drops by 25% say, it shouldn’t materially impact the strategy in the sense that growth assets are still protected from selling for well beyond the five years. After that long, most markets will have recovered. We find portfolios that follow this philosophy inevitably come through stronger.

Our Investment Philosophy still adheres to widely accepted portfolio principles such as quality research, diversification and asset allocation help to manage risk. There are a lot of factors that go into constructing a portfolio, but we believe this is the most reliable model and we are passionate about it.”

Improving economy

Improving economy

It is anticipated that the economy will start to improve in the coming year and this is likely to be reflected in company earnings in the later part of FY21 and continued into FY22. This should be driven by recovery in the construction, banking, industrial and consumer services industries.

As company earnings increase, dividends should rise and in turn this will continue to revive corporate confidence.

We are here to help

We understand that market instability can cause uncertainty, but this is where we can help. Our team of professional Financial Advisers can support you through the ups and downs and provide you with recommendations based on your personal situation.

The amount of instability we have experienced this year has certainly created challenges for people, but your adviser has the tools to be able to implement a range of strategies to help you weather the storm. If you have any questions, please contact us today.

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