Real benefits of dividends may lose out to the gleam of potential gains - 31st August 2003

Barry Dunstan - Australian Financial Review

After only a few months of rising share market prices, many investors are in danger of losing their focus on real returns and, instead, may be starting to fantasise again about capital gains. Smart investors, however, will be looking at the more substantial returns being achieved simply by banking higher dividends.

The returns which matter to any investor are the actual amounts they finally receive in their bank account. No-one can live week to week on the unrealised paper profits which can make up much of managed fund returns.

For instance, over the past 12 months, the 10 best-performed equity funds have produced returns ranging from 11.9 per cent to 6.75 per cent with only two of the returns in double digits. These numbers flatter the managers, since it includes strong returns in recent months and a strong July.

But, if we take returns of the major Australian equity funds for the 12 months to June, few, if any of the big name funds managed to break even, let alone produce a positive return for investors. Fair enough, perhaps, since theASX/S&P All Ordinaries returned a negative 1 per cent.

But many of the big name funds produced negative returns which went into double digits and anything less than negative 5 per cent was a good result. In contrast, of the 18 or so listed investment companies, more than 70 per cent of them produced positive returns for the year to June, with the big LICs strongly outperforming the index (not to mention the leading managed fund products). Australian Foundation returned 13.35 per cent, Argo Investments and Milton Corporation 9.5 per cent while several smaller operators managed returns up in double figures.

The question which investors should be asking is put by Peter Thornhill of Motivated Money: are the poorly-performing fund managers fishing in the same pond as other investors?

Thornhill contrasts a range of increased dividends from well-known companies with the performance of three managed funds he is holding. Against increases in dividend ranging from 5 per cent to 250 per cent, he says of the three funds, one increased income by 1 per cent, another by 7 per cent and the third had a 15 per cent fall in income. Even worse, none of the three funds achieved any realised share gains to distribute to investors for 2002-03.

As Thornhill notes, if these funds invest in the same pond as other investors, surely their dividend experience should broadly mirror the market. "In fact, they should be better as they hold fewer duff shares - because they are great stockpickers, aren't they?" he asks.

To confirm Thornhill's dividend numbers, a sample of mostly blue chip companies which have reported in the past week or so have produced an average increase in dividend of more than 13 per cent (and this excludes an abnormal rise in Lend Lease payments)

As examples, Foster's lifted annual payout by more than 10 per cent, Brickworks by 29 per cent, TAB by 15 per cent, Woolworths by 18 per cent, IAG by 9.5 per cent, Amcor by 7 per cent and AGL by almost 6 per cent. Some smaller stocks - such as Billabong, Sonic Health Care,Ridley and RG Capital Radio - produced increases in dividend payments averaging more than 20 per cent over the year.

But to avoid any bias in selecting stocks in this sample or in Thornhill's own portfolio, investors need only look at the performance of the listed investment companies as an example of what can be achieved by buying and holding a widespread portfolio of shares.

Perhaps the stark contrast between the results achieved by the larger LICs compared with virtually most of the managed fund equity trusts is part of the explanation for the continued phenomenon of LIC shares selling at premiums to their net asset backing figures.

The five biggest LICs - Australian Foundation, Argo, AUI, Djerriwarrh and Milton - mid-week were selling at an average premium to their net assets of more than 13 per cent. That is a substantial premium to pay for a portfolio of shares; in the distant past, the theory was that there should be something of a discount.

Presumably, investors must have some reason to pay more than the underlying share portfolio is worth. Perhaps it might be a demonstrated investment skill, stability in returns and, increasingly, management expense ratios which are only a fraction of the unlisted managed funds'.

Meanwhile, smart investors would remember the early examples of annual results tend to include the better profits; bad news always travels that much more slowly. Still, so far it's clear a lot of companies have decided to pay out more to shareholders.

Of course, this can be construed as a bear point. The argument can be mounted that directors who increase the amount paid to shareholders, rather than retain funds within the company, are making a judgement there may not be many attractive investment alternatives on which to spend the retained profits.

Smart shareholders won't necessarily argue with this; indeed, the more cynical might suggest distributed profits are safer in their bank accounts than sitting in the company, in danger of being sprayed up against the wall in ill-considered expansion or acquisitions.

As well, if expansion prospects don't appeal to boards, this may be a reflection of slower economic growth prospects and potential lower organic growth in profits. If this flows through to lower capital growth prospects for the shares, at least investors have the increased dividend payments as some offset.


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