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How dividend reductions will impact your income

By Leonie Di Lorenzo

Australian investors, particularly SMSF investors, have grown used to relying on strong dividend streams from Australia’s blue chip companies, particularly our big 4 banks. With those streams turning to a trickle, any investor relying on dividend income is potentially in trouble.

SMSF’s have been particularly hard hit as there is a reliance on dividend payments to fund pension payments to members. Traditionally, this has left little motivation for SMSF Trustee’s to look outside of Australian equities to find a consistent return on their investment.

It is well known SMSF’s hold a large proportion of their assets in Australian equities and cash, which includes term deposits. The most recent data released by the Australian Tax Office (ATO) shows on average, SMSF’s hold over 50 per cent of their assets between these two asset classes.

Investor’s Big 4 headache

Australia’s big 4 banks all rank in the top six listed shares held by SMSF’s, based on data shared by Class Super last year.

With falling interest rates being the focus for SMSF’s in 2018 and 2019, many were already feeling the pinch to their cash flows, and with record low interest rates set to continue and a new set of challenges resulting from COVID-19, the pain for SMSF’s is far from abating.

In early April, the financial system regulator, Australian Prudential Regulation Authority (APRA), began putting pressure on banks to reduce their dividends in order to firm up their capital positions until the full impact of COVID-19 could be quantified. This is prudent for the company’s balance sheet but will negatively impact SMSF’s reliant on dividends for income.

NAB released its half year results in late April, and announced a $3.5 billion capital raising ahead of an expected spike in credit losses. It cut its dividend by 64 per cent.

ANZ and Westpac followed in early May, citing COVID as a primary reason for deferring a decision on first half dividend. Other companies, particularly in hard hit industries like airlines, hospitality and tourism, will likely follow the bank’s response and cut, suspend or defer dividends.

While we have faith the big-4 banks can ride out the short to medium turn impact to profits, the resulting reduction in dividends is a burden investors are going to have to carry.

Investor’s seek diversification to counter dividend loss

Those SMSF’s in retirement phase who are on a zero tax rate will lose the most given the benefits of franking credits, and those who are required to withdraw to meet annual pension payments may now need to sell bank shares at a low price to ensure they have enough cash to meet the requirements.

The Governments temporary halving of pension minimums will likely go some way to reduce the pressure on SMSF cash flows, but will it be enough? For members who rely on this income to fund their day to day living expenses, it may provide minimal help.

It is no surprise then that SMSF's are looking to alternatives to support their weakening cash flow positions.

 What we are seeing

We have noticed an increase in SMSF's wanting to lock in returns and reduce risk. Current market volatility and uncertainty is driving a renewed focus on income options like corporate bonds and tailored investments that can give investors access to equities in a structure that can reduce risk, and which provides an agreed rate of income upfront.

The benefits of investing in fixed income for our SMSF clients is two-fold.

Fixed income tends to be more resilient during times of market volatility. Adding fixed income to an equity portfolio using bonds can have a dramatic effect in reducing volatility in portfolio returns, without overly hindering performance.

It is also a source of reliable income with coupon payments guaranteed by the issuer upfront and paid regularly, assuming the company does not default. For the 47 per cent of SMSF's paying a retirement income stream to members, this certainty provides some confidence that cash flow requirements will be met in times of stress.

Leonie is a self managed super fund specialist for Citi

This article first appeared in SMSF Adviser

 

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