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The importance of decent investment yield – especially in volatile times

Key points

- Assets with decent and sustainable yields are attractive in an environment of return volatility as they provide greater return certainty.

- Bank term deposit rates have collapsed, so it makes sense to continue to look elsewhere for income.

- Dividends tend to grow and be more stable than term deposits over time. The key for an investor is to work out what matters most: stability in the value of their investment or a higher/more stable income flow.  


The renewed turmoil in global financial markets on worries about global growth has  provided a reminder that we remain in an investment environment of constrained  capital growth and high volatility. This has several implications for investors  around interest rates and the yield investments provide. First, interest rates  are likely to remain low for longer: the Bank of Japan has cut interest rates  on excess bank reserves to -0.1%, the ECB is likely to ease further, the Fed is  backing away from rate hikes and the RBA is more likely to cut rates than  increase them. Second, it reminds us about the importance of the yield an  investment provides as opposed to just relying on capital growth. Third, while  a fall in the capital value of an investment is unsettling, the cash flow it provides is generally a lot more stable and becomes relatively more attractive  during periods of market declines. But what do we mean by yield? Why is it so important?  And where can it be found?

What is investment yield?

The yield an investment provides is basically its annual cash flow divided by the  value of the investment.

  • For bank deposits  the yield is simply the interest rate, eg bank 1 year term deposit rates in  Australia are around 2.4% and so this is the cash flow they will yield in the  year ahead.
  • For ten year Australian Government bonds,  annual cash payments on the bonds (coupons) relative to the current price of  the bonds provides a yield of 2.5% right now.
  • For residential property the yield is the  annual value of rents as a percentage of the value of the property. On average  in Australian capital cities it is about 4.2% for apartments and around 2.8%  for houses. After allowing for costs, net rental yields are about 2 percentage  points lower.
  • For unlisted commercial property, yields are  around 6% or higher. For infrastructure investment it averages around 5%.
  • For a basket of Australian shares represented  by the ASX 200 index, annual dividend payments are running around 5.3% of the  value of the shares. Once franking credits are allowed for this pushes up to  around 6.9%.

Yield and total return

The yield an investment provides forms the building block  for its total return, which is essentially determined by the following.  

Total  return = yield + capital growth

For some investments like term  deposits the yield is the only driver of return (assuming there is no default).  For fixed interest investments it is the main driver – and the only driver if  bond investments are held to maturity – but if the bond is sold before then there may be a capital gain or loss.  

For shares, property and  infrastructure, capital growth is a key component of return, but dividends or  rental income form the base of the total return. Prior to the 1960s most  investors focused on yield, particularly in the share market where most were  long term investors who bought stocks for dividend income. This changed in the  1960s with the "cult of the equity", as the focus shifted to capital growth. It  was pushed further through the bull markets of the 1980s and 1990s. Similarly  at various points in the cycle real estate investors have only worried about  price gains and not rents.

Why yield matters?

In  times like the present a focus on the income an investment provides is  important. First, with interest rates set to remain low or fall further, bank  deposit rates – already at their lowest in Australia since the 1950s – are  likely to remain low or go lower. Our view is that further falls are  likely as the RBA is likely to cut official interest rates to 1.75% in the next  six months on the back of global uncertainties, sub-par growth and benign  inflation. This in turn means an ongoing need to understand  and consider alternative sources of yield on offer.


   Source: RBA, AMP Capital

Second, a high and sustainable starting  point yield for an investment provides some security during volatile times like  the present. For example since 1900 dividends have provided more than half of  the 11.6% total return from Australian shares and as can be seen in the next  chart their contribution has been stable in contrast to the swings in the  capital value of shares.


   Source: Global Financial Data, AMP Capital

Dividends  are relatively smooth over time. Companies hate having to cut them as they know  it annoys shareholders so they prefer to keep them sustainable.  

Finally,  as baby boomers retire, investor demand for income will likely be high as the  focus shifts to income generation.  

Alternatives to term deposits for yield

The  chart below shows the yield on a range of Australian investments. Yields on  global investments tend to be lower.  


   Source:  Bloomberg, AMP Capital  

All  of these yields have fallen over the last few years as interest rates have  fallen, but as can be seen several of the alternatives do offer much more  attractive yields than term deposits.

  • Australian ten  year bond yields are now around 2.5%. This will be the return an investor will  get if they hold these bonds to maturity. They can generate a higher return if  yields continue to fall, but they are already very low. Global bond yields are lower, averaging around 1%.
  • After the house  price boom of the past twenty years the rental yield on capital city houses is  just 2.8% and that on apartments is around 4.2% and even lower after costs.
  • Corporate debt is  an option for those who want higher yields than term deposits but don't want  the volatility of shares. For Australian corporates, investment grade yields  are around 6.5% or less and lower quality corporate yields are higher. Sub investment grade corporate bond yields in the US are actually now yielding  around 9% as worries partly about loans to energy companies have pushed them  higher.    
  • Following the  turmoil of the GFC Australian real estate investment trusts (A-REITs) have  refocussed on their core business of managing buildings, collecting rents and  passing it on to their investors, with lower gearing. While their distribution  yields have declined as rental growth has not kept up with total returns of 15%  over the last 5 years, they are still reasonable at 4.8%.
  • Unlisted commercial property also offer attractive yields, around 6% for a high quality  well diversified mix of buildings, but higher for smaller lower quality  property. And it doesn't suffer from the overvaluation of residential property.
  • Unlisted  infrastructure offers yields of around 5%, underpinned by investments such as  toll roads and utilities where demand is relatively stable.
  • Australian shares  also fare well in the yield stakes. The grossed up dividend yield on Australian  shares at around 6.9% is well above term deposit rates meaning shares actually  provide a higher income than bank deposits. In fact the gap is now back to levels  seen during the GFC.


   Source:  Bloomberg, RBA, AMP Capital

Investing in shares of  course entails the risk of capital loss. But a way to minimise this risk is to  focus on stocks that provide sustainable above average dividend yields as the  higher yield provides greater certainty of return. The next chart compares initial $100,000  investments in Australian shares and one year term deposits in December 1979.  The term deposit would still be worth $100,000 (red line) and last year would  have paid $3200 in interest (red bars). By contrast the $100,000 invested in  shares would have grown to $1.04 million (blue line) and would have paid $50,770  in dividends before franking credits (blue bars). The point is that dividends tend  to grow over time (because an investment in shares tends to rise in value) and  to be relatively stable compared to income from bank deposits which vary with  interest rate settings.  


Key issues for investors to consider

While  there is a strong case for investors to focus on investments offering a decent  yield there is no such thing as a free lunch. All of the alternatives come with  a risk of volatility in the value of the underlying investment. In the case of  shares the key for an investor is to work out whether they want a stable value  for their investment in which case bank deposits win hands down or a  higher/more stable income flow in which case Australian shares win hands down.  

More  broadly, in searching for a higher yield investors need to keep their eyes  open. It's critical to focus on opportunities that have a track record of  delivering reliable earnings and distribution growth and are not based on  significant leverage. In other words make sure the yields are sustainable. On  this front it might be reasonable to avoid relying on some Australian resources  stocks where current dividends look unsustainable unless there is a rapid  recovery in commodity prices.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist  
AMP Capital


Important note: While every care has been taken in the  preparation of this document, AMP Capital Investors Limited (ABN 59 001 777  591,AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721,  AFSL 426455) make no representations or warranties as to the accuracy or  completeness of any statement in it including, without limitation, any  forecasts. Past performance is not a reliable indicator of future performance.  This document has been prepared for the purpose of providing general  information, without taking account of any particular investor's objectives,  financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document,  and seek professional advice, having regard to the investor's objectives,  financial situation and needs. This document is solely for the use of the party  to whom it is provided.