Investment Insights

Celebrating Ten Years At The Income Forefront

June 2020

To mark the 10-year anniversary of our innovation in the Australian income category,  Reece Birtles, Chief Investment Officer for Martin Currie Australia, Portfolio Manager for the strategy, and key architect of Martin Currie’s retirement income platform, answers ten questions about the Firm’s Equity Income journey to date.  Since its institutional market launch in May 2010, the Equity Income strategy has been at the forefront of retirement income solutions in Australia. The strategy now has over A$6 billion in funds under management for clients both locally and offshore, across segregated mandates, retail funds and SMAs.

First up, how has the strategy performed against its objectives?

Our aim 10 years ago was to build an income solution that solves the problem of what we call a ‘sufficient income for life’.

To us, this means a relatively high and stable franked dollar income stream to support annual expenses, income growth for inflation protection, and capital growth with lower capital volatility to manage longevity risk.

We are very happy to say that the strategy continues to achieve these goals since its inception in May 2010. 

The Equity Income Fund has exceeded its aim to provide a total income stream higher than that of the S&P/ASX 200, and has delivered this income with lower price volatility1.

Can you tell us about the genesis of the strategy?

The old view for most retirement products assume that when a client gets to 65, they automatically become more risk adverse and should move away from risky growth-style assets (i.e. equities, or growth-tilted balance funds) and more towards low risk defensive assets (i.e. term deposits, annuities, fixed income etc.).

Back in 2010, the high nominal income yields generated by low-risk fixed income and term deposit strategies following the GFC meant that a defensive asset allocation for retirees was relatively easy. But we knew that income from high yields was not going to be sustainable in a post GFC world. 

We felt then that income solutions that included growth assets would be required to maintain, or improve, the standard of living in retirement once these yields fell. This has proved to be true, with the cash rate steadily falling since then, and the RBA now lowering the cash rate to its lowest level ever seen. 

We developed our Equity Income solution for a specific client, but real-life situations also helped us to form our views and put the lived experience of retirees into focus. At the same time, my parents had just retired, having sold their small business and were for the first time trying to live off a retirement income stream at a time where markets were very volatile. It was a similar story for the family of our Head of Research, Michael Slack.

So why is Equity Income so different to other income options for retirees?

In 2010, retiree-focused equity products were few and far between (and in reality, they still are today) so we used first principles to turn traditional portfolio methodologies on their head by building a portfolio specifically aimed at providing an income stream for retirees. 

We wanted to improve the dollar income stream to facilitate a better standard of living. We wanted to lower income variability and provide inflation protection. And we also wanted to provide good income & capital growth for longevity. 

So, we built a strategy that invests in Australian securities, but looks very different to the broader market. 

  • We focus on the quality of businesses, and sustainability of dividend payments to enhance dividend security. 
  • We use a non-benchmark portfolio construction approach to limit security and sector concentration risk, and this helps avoid income shocks. 
  • We align our portfolio construction with inflation drivers. 
  • We fully value franking credits for retirees and keep turnover low. 
  • We avoid costly derivatives strategies for income enhancements or capital protection that could be detrimental to long-run income and returns. 

This looks very different to term deposits, annuities, fixed income, or even ‘high yield’ equity strategies. 

Looking back, what has been the highlight of the past 10 years for you?

I think what I have found really satisfying is how the theory from which we built the strategy has come into fruition by resonating with the real-life situations of retirees and charities. The portfolio is doing what it is supposed to do, generating a ‘sufficient income for life’. 

What has been your biggest learning?

Being different to the benchmark1 has its ups and downs, but staying true to our income objective is what really matters and gets results in the end2

What was your best and worst stock picks over the last 10 years?3

Most importantly, when we look at this question from an income perspective, our portfolio design works. 

Our ~8% p.a. franked dividend yield is not dominated by any one stock. No one individual stock contributes more than 5% of the total yield. The top 5 yielding stocks make up ~20% of the total, the top 10 less than ~40%, the top 20 less than 60%. 

This income source diversification is testament to our portfolio construction methodology that ignores benchmark weights and limits stock concentration to avoid income shocks.

Diversified 10-year yield contribution (including franking) (% p.a.)4

From a total return perspective, ASX & JB Hi-Fi have been the best overall contributors, while AMP (due to the Royal Commission issues in 2018/2019) has been the poorest. ASX & JB Hi-Fi demonstrate the high Quality and growing income characteristics we seek for the strategy from differentiated stocksi.

Looking from a relative return perspective (as we know clients still do despite the benchmark unaware nature of the strategy), versus the S&P/ASX 200 Accumulation Index our underweight to BHP has helped the most over the 10 years, while not holding CSL has been the biggest detractor. This is not unexpected given the structural underweights we hold versus large caps and low dividend payers.

How has the strategy performed through COVID-19, and how do you expect it to perform in the post COVID-19 world?

The COVID-19 induced falls in February/March 2020 were the first significant market fall the strategy has experienced in its 10 years. On a total return basis, it’s disappointing that the strategy fell further than the index, but we must admit that this crisis has been unique. 

The unprecedented and unexpected impacts from COVID-19 have also meant that the near-term outlook for dividends remains challenging, but we worked hard to carefully re-position our portfolio and protect the near-term income stream while ensuring that the long-term income potential of the portfolio remains robust. And true to our income focus, we have achieved a much lower reduction in our dividend stream than the broader market since the start of the crisis.

Going forward, we recognise that the fall in income is a critical issue for investors who rely on that income for living expenses. But now is also a great opportunity to build a diversified portfolio of businesses with the ability to generate sustainable dividends at attractive valuations. An example of this is our recent investment in BHP. In the past we had seen resource companies such as BHP as having high volatility of their earnings and dividends, but we added BHP in March as it was reasonably priced, and the positive outlook for the iron ore price means it can offer a differentiated dividend stream to the consumer environment that is exposed to the COVID-19 crisis. 

How has the strategy evolved over this time? 

The investment philosophy of the strategy has been very stable over time, although we have made enhancements. For example, we have bolstered our focus on ESG, we have worked on improving diversity of thought and mental models within the team. 

But importantly, when periods of underperformance have occurred, often due to the our structural underweight towards large caps and greater focus on domestic stocks, this has not tempted us to change our strategy.

What is next for the Martin Currie income platform?

The strategy has already gone on to spawn a range of client-driven income solutions such as Australia Real Income in late 2010, Diversified Income in 2014, Ethical Income in 2015 and Asia Pacific Real Income in 2016. 

In July this year, we will be launching the Global Real Income strategy, which extends the Real Income franchise to access global opportunities driven by the demographic mega trends seen in Australia and Asia.  

If you could go back to strategy launch in May 2010, what advice would you give yourself? 

It takes time to build something different, but what matters is that when you put client’s interest first, you know the probability of success is very high.

1Source: Legg Mason, Martin Currie; as at 30 June 2020. This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Accumulation Index. 

2 This strategy is not constrained by a benchmark, however for comparison purposes is shown against the S&P/ASX 200 Accumulation Index. 

3 The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.

4 Source: Martin Currie Australia, Factset; as at 31 May 2020. Data calculated for representative Martin Currie Australia Equity Income account; in Australian dollars, gross of management fees. Assumes zero percent tax rate and full franking benefits realised in tax return.

Past performance is not a guide to future returns.

Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849 AFSL 240827) is part of the Global Legg Mason Inc. group. Any reference to ‘Legg Mason Australia’ is a reference to Legg Mason Asset Management Australia Limited. Legg Mason Australia is the responsible entity of the Legg Mason Martin Currie Equity Income Fund (ARSN 150 751 821) and Martin Currie Australia, a division of Legg Mason Australia, is the fund manager. Before making an investment decision you should read the relevant Product Disclosure Statement (PDS) carefully and you need to consider, with or without the assistance of a financial adviser, whether such an investment is appropriate considering your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Legg Mason The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed herein were, or will prove to be, profitable.