As super funds continue their search for yield, Raewyn Williams takes a look at one source of income that is very close to home: franking credits.
Franking credits boost yields on Australian equity portfolios and can be targeted during the stock selection and portfolio construction processes.
However, to maximise the benefits of franking credits and address any additional risks a franking strategy may contain, super funds need to be careful.
Franking credits are not a ‘free lunch’ and how the equity portfolio is constructed really matters.
A recent paper by the research team at Parametric revisited earlier work with a more detailed examination of how franking strategies can be used in an income-seeking portfolio.
We show how super fund members in pension phase should benefit more from a cleverly constructed franking-aware equity portfolio than those in the accumulation phase – an important insight as super funds consider their retirement product design.
All members, though, can benefit from the fund adopting sophisticated optimisation techniques to boost yield from franking credits, rather than settling for blunt screening or tilting approaches.
Optimisation portfolio construction techniques can deliver another important benefit to funds over blunter screens or tilts.
A sophisticated fund manager can design a finely-tuned portfolio to cater to an individual fund’s objectives and risk appetite for things like yield, tracking error, concentration, sector and style factor risks, turnover and volatility.
In the hypothetical 11-year backtest of an S&P/ASX 200 portfolio presented in the research (which did not consider fees or transaction costs), the use of optimisation techniques, rather than a simple screened approach for favouring stocks with higher franked dividends, delivered an additional 20 basis points a year in excess after-tax returns, with less volatility and lower tracking error for a super fund member in the accumulation phase.
For pension phase members, the after-tax return pick up was higher, at 26 basis points a year. These hypothetical results excluded off-market share buybacks, which the paper notes in reality are additional opportunities for pension portfolios with income-seeking objectives.
Here we discuss several key trends that could whet a super fund’s appetite for pursuing franking credits to help with an income-seeking portfolio. These are:
Raewyn Williams is the managing director of research at Parametric Australia.