Tracking the chase for dividend yield

An ageing population that is living longer, and a lower fertility rate, is dramatically changing Australia’s demographic profile. The 65 plus cohort represents an increasingly higher proportion of the population. This demographic shift is not unique to Australia, however, the simultaneous transition in the retirement savings market, due largely to the rapidly growing self managed super funds, is. This article analyses both of these transitions and the impact they are having on the Australian share market.  The chase for dividend yield is far from over.

Over the past 100 years, Australia’s population structure has changed markedly.

In 1911, Australia’s population was a typical pyramid shape - bottom heavy with the population skewed to younger age groups (see figure 1, left chart). By 1961, the pyramid had widened reflecting the growth in Australia’s population, particularly in the 0-14 age bracket (the dark shaded area) - reflecting the birth of the baby boomers post World War 2 (1946 through to 1964).

Pyramids to boxes

By 2004, the pyramid had changed shape, most notably around the middle, with the baby boomers now aged in their 40s and 50s.  By 2051, the Australian Bureau of Statistics (ABS) is projecting Australia’s population structure to be somewhat different, to be more top heavy, with people aged 80 plus representing a significant percentage of the population – more than those being born (ie 0-4 years of age). In fact, the population structure is projected to look more like a box than a pyramid.

Figure 1: The changing shape of Australia’s population

                        1911                                           1961                                          2004

Source: Australian Bureau of Statistics

What’s causing the change in shape?

It’s not only the ageing of the baby boomers that is causing the shift in Australia’s demographic structure.  Increasing life expectancy, thanks to the miracles of science, is another contributing factor.  According to the Australian Bureau of Statistics (ABS), the average life expectancy for females born between 2010 and 2012 is 84.3 years of age, up from 58.8 for those born just over 100 years ago in 1910. The average life expectancy for men is 79.9, up from 55.2.

A lower fertility rate is also playing an important role.  Figure 2 shows Australia’s fertility rate has fallen sharply since the early 1960s. A fertility rate of 2.0 (ie two children) is considered to be the replacement rate for the population – two children replaces two parents.

There was a marked increase in Australia’s fertility rate in 1940s up until the early-to-mid 1960s, with the fertility rate rising from around 2.5 children to a peak of just above 3.5 due to the baby boom. 

Australia’s fertility rate has been below 2 since the mid-1970s. The Howard Government’s ‘baby bonus’ first announced in 2002 helped the fertility rate pick up slightly to 1.8 in 2006, but it still remains below the replacement rate of 2.

Figure 2: Australia’s total fertility rate: 1921-2006

Source: Australian Bureau of Statistics

Another interesting way to understand the changing shape of Australia’s population is to look at the shift in two broad age groups as a percentage of the population: the 65 plus age group versus the 0-14 age group. The 65 plus age group as a percentage of the total population has increased from less than 5% in 1901 to current levels of around 15% - and will surpass the 0-14 years age group before 2020.  (Note, the marked acceleration in the 65 plus ratio from around 2010 as the baby boomers started to move into this age bracket.) The 65 plus age group is projected to keep increasing to 27% of the population by 2050. Meanwhile, the 0-14 age group has largely been in a downward trend and is projected to keep decreasing as a percentage of the total population until about 2050 where it will stabilise at around 15% of the population (down from 35% in 1901).

Figure 3: 65+ versus the under 15s (1901-2100)

Source: Australian Bureau of Statistics

Of greater economic significance is the forecast decline in Australia’s ‘inverse dependency ratio’. The ratio of the working age population to dependents (defined as those aged less than 15 years of age and 65 plus) is expected to fall from around current levels of 2 to 1.5 by 2060.

Figure 4:  Australia’s inverse dependency ratio forecast to decline

Source: ASX, Haver, UBS

Source: Population Reference Bureau (PRB). NB. Projected populations are based upon reasonable assumptions on the future course of fertility, mortality and migration. Projections are based upon official country projections, series issued by the UN or the US Census Bureau, or PRB projections.

Demographic shift and the chase for yield

A shrinking working age population has significant implications for the Australian economy and the share market.  An ageing population places a financial burden on the economy through higher demands on public healthcare costs and social security from retirees; while tax revenue and consumer spending is dampened due to the lower proportion of the working age population. 

Japan has experienced the demographic shift already and in a more pronounced manner due to negligible immigration, persistently low fertility rates and rising life expectancy. Currently, Japan has 25% of its population aged 65 plus, whereas for Australia it’s 15%. As mentioned above, by 2050 the proportion of Australia’s population aged 65 plus is projected to be around 27% ie greater than Japan currently.

In Japan, over the last several years investors have been seeking high-yielding investments around the world due to low interest rates and an ageing population seeking higher income than what is available in their own country. The Australian equity market has been a beneficiary of this demand.

Will Australia follow Japan?

Australia’s lower fertility rate has resulted in a fall in the ratio of 20-34 year olds to 40-49 year olds (light blue line in figure 5). Those aged in the 20-34 year bracket are typically net borrowers as they buy their first homes. They are in a sense the ‘demanders of credit’.  Those aged 40-49 on the other hand, are typically net savers as they have either paid off, or largely paid, off their mortgages. They are ‘suppliers of credit’.

During the 1970s and early 1980s the baby boomers came of age and started demanding credit, but as figure 5 shows this ratio has declined and is projected to remain low (red line) as the baby boomers continue to age.

This age bracket ratio is also plotted against Australian long bond yields given the supply/demand dynamics for credit that these cohorts create. As shown in Figure 5, there is a close correlation between the ratio and bond yields. As the baby boomers have started retiring, bond yields have declined. It would suggest that going forward, as this ratio continues to decline, interest rates will remain lower for longer, although there will be cycles within that.

Retirees with savings are typically buyers of term deposits and bond funds. However, low rates and the absence of a retail corporate bond market in Australia means they are looking elsewhere to satisfy their appetite for yield (ie equities) - just as Japan has done for some time.

Figure 5: Age brackets and long bond yields

Source: ASX, Haver, UBS

The retirement savings market is also undergoing a transition

The rise in grey power is impacting the Australian share market quite significantly via the growth in self managed superannuation funds (SMSFs). According to the Australian Tax Office and Credit Suisse, SMSFs received an average of around $15 billion per financial year in net inflows over the nine-year period from 2003-04 to 2011-12.

What’s of a concern, is that SMSFs appear to have a distorted asset allocation (see figure 6), with a significant bias to direct domestic equities (32%) and property (28%).

Figure 6: SMSF asset allocation as at September 2013

Source: ATO, Credit Suisse estimates

Anecdotal evidence suggests that the direct equity exposure is limited to the big four banks and blue chip high-yielding stocks. What’s more, SMSFs are continuing to buy these stocks, regardless of value or where we are in the market cycle.

The boards of companies are becoming increasingly aware of the growth and influence of SMSFs and their increasing demand for higher dividends.

As noted above, the demographic shift will potentially lead to lower economic growth, and this increasing demand for higher dividends by SMSFs could exacerbate this problem as companies feel pressured to meet their demands – at the expense of investing in their businesses.

Dividend yield strategies likely to continue outperforming

This demand for high-yielding equities has obvious implications for yield-driven strategies. Over the past 12 or so years, dividend yield strategies have outperformed the broader share market by a comfortable margin.

There is a strong correlation between the change in the number of retirees and the performance of dividend yield strategies. Figure 7 shows the percentage change in retirees (with the red line representing the forecast change) and the outperformance of dividend yield strategies (light blue line).  As the number of retirees has increased, dividend yield strategies have outperformed.

Sustained demand for high-yielding equities for at least the next two to three decades as the percentage change in the number of retirees continues to increase, suggests that dividend yield strategies will continue to outperform for quite some time yet.

Figure 7: The number of retirees and dividend yield strategies are positively linked

Source: Haver, Kenneth French, UBS

An active, value-driven approach can help to navigate through the volatility

We would however caution against investing directly in a handful of well known high-yielding stocks and locking them in the bottom drawer. This is not an ideal way to invest, due to the risk that pockets of yield stocks may become more vulnerable to shocks as their valuations become stretched. 

This risk is exacerbated by SMSFs, which tend to hold stocks directly in a relatively passive ‘buy and hold’ manner as well as invest in index funds and Exchange Traded Funds (ETFs).

To minimise the potential of a portfolio of yield stocks being prone to such vulnerabilities requires active analysis and continual valuation of stocks.  Well-resourced active managers, such as Tyndall AM, who have yield strategies but with a focus on value is one way for investors to help navigate through this potential volatile and uncertain period. It may come as a surprise to many investors but a large portion of outperformance in our high-yield funds has actually been derived from ‘other’ non-traditional high-yielding areas where opportunities have arisen in specific stocks, rather than the traditional high-yielding stocks.  

Summary

Australia is undergoing a dramatic demographic shift, not unlike many other developed countries. The ageing population which is living longer together with a lower fertility rate is having a significant impact on Australia’s financial markets.  With long bond yields expected to stay at relatively low levels, the demand for high-yielding equity strategies is likely to continue.  SMSFs are key drivers of this investment theme and no one is more aware of this than company boards, posing them with a dilemma: pay higher dividends or invest in business?  This, combined with a shrinking workforce will pose significant headwinds for the Australian economy for many years to come. Buy and hold strategies of traditional high-yielding stocks, such as the big four banks and high-yielding blue-chip stocks may not be the best investment strategy in this low growth and volatile environment.  Active management with a focus on value can help investors navigate through this potential volatility.