Dividend payouts in a rising interest rate environment

Michael Price, Portfolio Manager for the Ausbil Active Dividend Income Fund, discusses the strategy and track record of the fund, and the performance of dividend funds in an environment of volatility and falling valuations.

Tim McGowen: We’re talking to Michael Price, who is the Portfolio Manager for the Ausbil Active Dividend Income Fund. Michael, can you give us an introduction to the fund?

Michael Price: Yeah. So, the Ausbil Active Dividend Income Fund, it’s a slightly different type of dividend income fund. Rather than hold companies that pay high dividends, we actually get the extra dividend income by collecting more dividends throughout the year. We take advantage of the fact that not every company pays its dividend on the same day. We hold a portfolio of stocks that we like and we think will outperform. And we just increase the weight of those stocks when the companies get to that time of the year when they pay their dividends.

Tim McGowen: And, Michael, what’s the fund aiming to achieve for investors?

Michael Price: It’s got three different types of objective. The first, of course, is to pay very high levels of dividend income and franking credits and to pay those distributions monthly over the year. The second is total return. We do want to outperform the market. Ausbil’s got a proud 25-year track record of outperformance and we certainly want this fund to do that as well. And then the third thing is a lot of our client base is pensioners, retirees, people who do like those franking credits, and we’re very aware of risk for them, so we want to do this outperformance in quite a risk-controlled manner.

Tim McGowen: Now, turning to performance, can you give us a brief overview of performance?

Michael Price: Yeah, really happy with the performance. The fund’s been going just over four years now, and we’ve met all three of those objectives. So, in terms of income, we’ve been able to distribute over 7 per cent each financial year, even in the worst of the pandemic. Now, that does include franking credits but, yeah, very happy with that as a distribution, and it’s been far in excess of what the benchmark’s been able to provide. In terms of total return, we’ve comfortably outperformed the S&P ASX 200 index. And, interestingly, two-thirds of that outperformance has been in months when the market has fallen, so that’s provided a bit of protection for those risk-averse clients.

Tim McGowen: Michael, what does a rising interest rate environment historically mean for dividend payouts?

Michael Price: Well, the first thing to remember is that dividends come from earnings, and earnings are a lot more stable than valuations. So, what we’ve seen over the last couple of months is as interest rates or bond rates in particular have gone up, there’s been a real negative impact on valuations and share prices have fallen. But, interestingly, we haven’t seen forecast earnings come off at all, so as long as earnings are maintained, dividends will be able to be maintained as well. Now, the risk is that higher interest rates and cash rates in particular from the Reserve Bank might lead to a slowdown in the economy and potentially even a recession, and that would lead to a drop in earnings and then dividends. But the reserve bank doesn’t want to cause a recession. Our base case is that they won’t. So as long as earnings can be maintained, dividends can be maintained as well, even in the face of higher cash rates.

Tim McGowen: And, Michael, given recent market volatility, how do valuations look across your universe?

Michael Price: Interestingly, the recent drop in share prices has come entirely due to a lowering in the valuations rather than a drop in earnings, and so, because of that, valuations actually look pretty attractive. They’re quite a bit lower than recent averages, and in fact, they’re quite a bit lower than longer-term averages when bond rates were even higher again. So, as long as the earnings are able to be maintained, valuations are actually looking pretty attractive.

Tim McGowen: And, Michael, from a portfolio construction perspective, what are some of the changes you’ve made in the portfolio recently?

Michael Price: The thing which has really driven the market so far this year is that inflation has been a lot higher than we expected, than the Reserve Bank expected, and really, what anybody expected, in particular here in Australia. And so, because of that, we’ve had to change the shape of our portfolio a bit, partly to take advantage of the companies that are in a sense benefiting from the higher inflation. It’s higher energy prices driving inflation, so energy companies are actually making a lot of money on the back of this. The other thing we need to be careful of is finding companies that can maintain their margins in the face of this higher inflation, so we’ve been moving to companies with some pricing power which we think will be able to maintain or grow their earnings despite the pressures from this higher inflation.

Tim McGowen: And, Michael, any sectors in the portfolio you’re particularly excited about at the moment?

Michael Price: There are a few things we’re excited about at the moment. Firstly, purely from a dividend point of view, we’re going to see some great dividends coming from the iron ore companies as a result of the very high iron ore price we’ve seen over the last year. We’re going to see some great dividends from the energy companies as a result of the very high oil prices we’ve seen over the last year. Then in terms of companies that can provide decent dividends but also grow going forward, really like the insurance sector at the moment. They’re a good example of a company with pricing power where they can increase their revenue, and they’ve maintained their margins even in the face of higher interest rates. And thirdly, we’re looking for companies that can continue to grow, even in the face of a possible slowdown in the Australian economy, so quality growth companies, healthcare in particular, that’s another sector that we find pretty attractive right now.

Tim McGowen: And, Michael, what are some of the risks you see in the markets moving forward? And what’s your view on the upcoming reporting season?

Michael Price: As always, there are some significant risks out there. Firstly is the risk that Australia and/or the rest of the world go into recession as a result of the higher interest rates in particular. Secondly, the war in Ukraine is a worry. That can always escalate, and in particular, that could send Europe into recession, and that could have some flow-on effects for the rest of the world. And thirdly is COVID. So far, the mutations might have been more transmissible, but they haven’t been more dangerous. If they do have a more dangerous variant come through and we all get sent back into lockdown, then that would also be a significant slowdown for the Australian economy. But our base case is optimistic. As I said, earnings are as high as they’ve ever been. Dividends are as high as they’ve ever been. The forecast view is for them to grow over the next 12 months, and this reporting season in particular should give some really good outcomes for both earnings and dividends as companies have rebounded from the worst of the pandemic and the shutdowns.

Tim McGowen: Michael Price, thank you for your time.

Michael Price: You’re welcome, Tim.

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