Quick Q&A with the CEO: What are the implications of the ongoing quest for yield?

Yield chasers have pushed up the prices of the big banks and other blue chips to near record highs  but what are their valuations like? Where should new investors be looking for income? Will yesterday's interest rate cut intensify the chase for yield and drive prices even higher?


Scott Schuberg, Rivkin CEO: The landscape for income investing in ASX shares has been highly competitive ever since the rate cutting cycle recommenced in November 2010. With such a large base of SMSF investors seeking a base of yield to prop up pensions, Rivkin certainly fields demand from its clients to find risky assets that will help fund the income gap between what cash will give them and what their lifestyles cost them.

All the banks are expensive given that forward earnings analysis leaves little room for disappointment, and CBA is certainly priced for perfection. The 2014 financial planning scandal is also in the rear-view mirror now for CBA, so it is enjoying a recovery from that episode which has helped propel its share price to stratospheric levels, while the remaining three of the Big Four are merely breaking their 12-month rolling highs. But given the Big Four occupy such a large part of the market, inflows into funds that focus on the ASX 20 or 50 will give a disproportionate kicker to the Big Four relative to the rest of the index. A lot of this flow of money is pumping up the banks with little regard for valuations.

So the problem that this creates, and it is a serious problem for SMSF investors, is that yields fall as the price goes up and investors are forced to have to either look at riskier assets or delve into parts of the market that they don’t understand well. For instance, the ASX has many resource names that are bombed out at present and are showing a very high forecast yield on a theoretical basis, but the ability for some of these names to maintain earnings and dividends is highly questionable. So investors need a lot of help. Investors might just plug in a yield scan into a filter on their stockbroking platform and pick up, what will ultimately be, false reads.

Yesterday's RBA cut put the boot into this part of the market that is hungry for yield. Yes, if you’re already holding a portfolio of high yield stocks, you may well benefit from the drop in interest rates as investors get more desperate and buy up the stocks you already own; but if you’re just constructing a portfolio now, what should you do?

Rivkin is a big fan of finding yield in the secondary market for hybrid securities. A big part of our Rivkin Local Model Portfolio is occupied by convertible notes, convertible preference shares and capital notes. These are a bit like corporate bonds and behave as such in an interest rate cutting cycle – as risk-free returns get lower, interest in these notes generally becomes more intense and the price goes up. However, many of the issues price themselves on a base of bank bills, which will vary (more or less) in line with cash interest rates. So one needs to select carefully.

While the big banks will list debt that is generally quite unattractive because they know investors consider them to be virtually risk free, other issues from companies that don’t have the ratings luxury of the Big Four can be quite attractive. One only has to look to the second-tier issuers like Macquarie, Bendigo and BOQ to get a great clip above the Big Four when it comes to ASX-trade debt.

Investors can build a diversified portfolio of listed ASX debt and achieve yields upwards of 7% while only taking moderately more risk than they do with the Big Four – you just need to know where to look.

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