At a time of extremely low global real yields, investors should consider diversified portfolios of low volatility and high yielding equities to supplement their income. The New Zealand and Australian equity markets provide attractive investment opportunities. Investors have historically generated income in their portfolios using fixed income and cash investments, and diversified their portfolios by investing in equities and real assets such as property and commodities, to provide capital protection and to deliver growth.

This ‘balanced’ approach has placed bonds at the low end of the risk spectrum and equities at the high end. Traditionally, investors have considered bonds and cash as their income generating asset classes, and equities as providing a source of long-term real capital protection. Over the very long term, equities have actually done a good job of protecting wealth after inflation.

However, several significant forces are changing the way investors think about portfolios. Global interest rates are near record lows and it is getting harder to generate real, after tax and fee returns from cash and bond portfolios (see Fig. 1). We don’t see this changing much over the next few years. While there is a path to increase interest rates in several of the developed markets, we believe that generally interest rates are likely to stay lower than in the past. As a result, global bonds and cash yields are not currently satisfying investor appetite for income.

We believe that investing in a diversified portfolio of Australian and New Zealand equities targeting income and growth characteristics can provide a solution for global investors in the search for yield.

New Zealand and Australian real 10-year bond, cash yields and equity yields are among the highest in developed markets (see Fig. 2). This offers global investors with not only income opportunities, but the potential for capital growth.

Resistant to crises
New Zealand is one of only a few developed countries to have weathered the global financial crisis in good shape and maintain a strong sovereign credit rating throughout. The country had already learnt the lesson of its own financial crisis in the mid 1980s, which had prompted widespread reforms to create a world leading framework for monetary policy and fiscal responsibility. As a result, New Zealand entered the global financial crisis with a strong banking system, low inflation, and low levels of government debt.

The New Zealand economy has also benefited from three additional drivers of growth. Firstly, following the devastating February 2011 earthquake in Christchurch, the country’s second largest city, there has been a surge in residential and commercial construction, funded by insurance cover from global reinsurers. This is set to continue for many years to come.

Secondly, New Zealand has benefited from a number of new free trade relationships. There is a structural change occurring in consumption habits in Asia, and New Zealand has the agricultural land, technology, sunshine and water to feed the continent’s growing middle classes there.

Finally, New Zealand is experiencing record net migration, equivalent to around one percent of the population, as foreigners are drawn to the economic prospects in New Zealand, and fewer locals are departing to foreign shores as they see better opportunities at home.

Combined with this macroeconomic backdrop, New Zealand has a vibrant capital market, which has seen new equity listings across a number of sectors. Government stability, strong growth of the local savings industry and the proximity to growing Asian markets are factors that have helped contribute to the country’s growth in the equity market in the past year.

Moreover, New Zealand’s equity market continues to provide a cash yield to global investors of around 4.5 percent, while local investment grade bonds also yield around 4.5 percent. These yields look good in the context of local inflation, which is below two percent.

Robust activity
The Australian market has also weathered the global financial crisis in relatively good shape. However, we acknowledge that the tapering off in the resource sector boom is providing some headwinds for parts of the market, as is some regulatory reform. Domestic economic activity is relatively robust and the central bank is in no rush to raise interest rates with positive but modest growth, and inflation remaining tepid. Outside of the resource sector we still see many investment opportunities for income and growth with market valuations relatively attractive.

New Zealand and Australia have typically been much higher dividend yield-paying markets than their global counterparts. Part of this reflects the market composition of more defensive and mature companies such as utilities and Telco’s, but also investor’s appetite for income. The average cash dividend for New Zealand and Australia in equities over the last 10 years has been pretty similar at 5.4 percent per annum and 5.5 percent per annum respectively. This would place both countries at the top of developed markets for dividend yields over this period.

We do not see this changing materially over the medium term and, in fact, the Australian and New Zealand markets currently have the highest market dividend yield forecasts. In addition, New Zealand and Australia have stable political environments, relatively strong government fiscal positions and strong external credit ratings (see Fig. 3).

Companies in Australia and New Zealand are also generally in a good financial position post-global financial crisis. Many companies have surplus cash or under geared balance sheets and are either returning cash to shareholders via dividends or undertaking other capital management initiatives.

As such, capital efficiency and earning higher returns on invested capital is becoming an area of increasing focus for shareholders. Many listed companies are standing up and listening, especially in an environment where it is difficult to secure growing revenue and earning is difficult.

One of the other features of the New Zealand market has been the period of strong returns delivered with lower risk than other markets. This has attraction for global investors who not only have income needs, but also want a lower volatility investment.

While equity market volatility has been suppressed recently with central banks delivering monetary impulse through lower rates and quantitative easing, we would expect a return to more normal levels of equity volatility. However, the New Zealand market and to some extent the Australian Industrial market still provide investors with lower risk investment opportunities.

Lower volatility
When investors look at investment opportunities in Australia and New Zealand from an income perspective, chasing the highest yielding companies in the market is not the best approach to take, not only from a return perspective, but also from the volatility of returns that arises from it.

To take advantage of the income, low volatility, and market stability that the New Zealand and Australian markets provide, Harbour Asset Management launched an Australasian Equity Income Fund to cater for investors looking for income and capital growth, but also with an emphasis on lower volatility. The fund provides investors with a diversified portfolio of 40 to 60 stocks across both New Zealand and Australia.

Through a filtering and quantitative process the investment process seeks to identify those companies that have sustainable dividends, some earnings growth and have exhibited characteristics of low volatility of historical returns and earnings.

Harbour Asset Management has emerged as the premier New Zealand investment manager, being named World Finance’s Best Investment Manager, New Zealand, in both 2014 and 2013 when this accolade was first awarded. Supporting this, Harbour Asset Management was also named Morningstar Fund Manager of the Year, for New Zealand in 2014 after winning both the domestic equities and fixed interest awards. Harbour Asset Management is regarded for its well conceived and timely communication with investors providing astute insights into both portfolio positioning and market developments.

Harbour intends to launch a European domiciled UCIT Fund in 2015 that will enable European investors to invest in the Harbour Asset Management Australasian Equity Income strategy.