Income generation and the ‘income generation’

Funds Management

by Carolyn Herbert

Transcription of Finance News Network Interview with MLC Income Builder Fund Head of Australian Shares Research, Peter Sumner
Whitney Fitzsimmons:Hello I’m Whitney Fitzsimmons for the Finance News Network and joining me today from the MLC Income Builder Fund, is Head of Australian Shares Research, Peter Sumner. Peter, welcome back.
Peter Sumner:Thanks very much for having me.
Whitney Fitzsimmons: The MLC Income Builder Fund is focused on growing distributions. What strategies does it use?
Peter Sumner: The Fund actually employs active managers and we employ those managers, with very specific mandates. And those mandates are basically designed to focus on the objective of the Fund, which is growing those cents per unit distribution. So the managers typically focus on companies paying dividends. There is a little bit of capital distribution from time to time, as a consequence of corporate activity. But the core of the income is coming from franked dividends, which are coming from the companies.
Whitney Fitzsimmons: Why does an investment objective rather than a common market benchmark, deliver more accurately to an investor’s desired outcomes?
Peter Sumner: We’ve tended to find that there aren’t specific benchmarks that necessarily meet those objectives, which people are seeking. So for example with MLC IncomeBuilder, we’re talking about growing cents per unit, rather than beating the benchmark. And so we can do that more accurately by specifying, what we really desire from managers who are managing the portfolio. This allows us to direct whether we’re looking for, for example, more capital or more income, or if you want a particular feature and not another feature. So it just allows us to tailor to that objective a lot better.
Whitney Fitzsimmons: The Fund uses specialist investment managers. What’s the advantage to using active managers?
Peter Sumner: In markets, risks are changing all the time. So the managers really need to recalibrate the risk and the expected return that they’re getting from the portfolios, and from the stocks. So we think it’s a better way to invest by employing active managers. They need to employ some judgment about the environment that they’re operating within. And also, when risks aren’t being rewarded, what to actually do with those stocks or risks in the portfolio, from time to time.
Whitney Fitzsimmons: What’s the advantage of selecting investment managers who focus on the long-term?
Peter Sumner: A lot of costs can be consumed by churning through portfolios. The other thing that managers can become subject to, are short-term fadsor momentum, for example. So what we really look for is investors and those investorsare focused on the long-term. And generally when you’re investing in a company, it takes a while for a company strategy to evolve. So again, for this Fund, managers are focused on income, they’re focused on dividends, sustainability of those dividends through time. And that allows the managers to really extract that value from those companies, through the long-term.
Whitney Fitzsimmons: Moving on to performance. How has the Fund performed since it started and more recently?
Peter Sumner: The Fund’s actually performed very well since inception. We’ve delivered 16 out of 20 years of growing distributions, over that period of time. And more recently, we have actually distributed some capital gains, because the market’s been very strong. But there’s been some upside there as well. Toll Holdings Limited (ASX:TOL) for example, which was in the portfolio, got taken over by Japan Post Holdings Company Limited at a 40 per cent premium.
Whitney Fitzsimmons: So which companies have been supporting your performance, and what are some of your larger positions?
Peter Sumner: The sorts of companies, again, dividend focused. So at the moment we have a number of the banks - four banks, Telstra Corporation Limited (ASX:TLS) for example. And all these companies have been growing earnings modestly, in the recent past. And that actually again, helps in terms of delivering those tax effective distributions, because all those are being franked. More recently as well, we’ve had companies like Suncorp Group Limited (ASX:SUN), which have also helped us where they actually distribute a bonus dividend. And again, that’s helping us deliver that growing cents per unit distribution, year on year.
Whitney Fitzsimmons: How useful are franked dividends and participating in share buy-backs? 
Peter Sumner: I think about that as the icing on the cake. So from year to year the markets go up and down, we get capital gains, we get our regular dividends. And then the franking behind that is essentially, allowing us to improve the after-tax consequences of the Fund. So it’s generally forgotten, it’s probably under-priced by the market. And we tend to focus on that, because that’s the real return that an investor gets at the end of the day.
So if you think about it from a perspective of compounding for an accumulator. For example, a 20 basis point increase in distributions compounded over 20 years is equivalent, to around about four per cent. And on a large amount of money, that’s quite a substantial amount of money that can help people retire, or in their pension phase over their lifetime.
Whitney Fitzsimmons: How do market factors such as low rates and the Federal Budget, affect the Fund’s composition?
Peter Sumner: We’ve seen for example, with the very low interest rates, there’s been a drive for yield. So banks, utilities, telcos, have been really well bid in the market. There’s a consequence of that, we can find that many economic factors driving the market can cause overvaluation, or things to be fully priced. And again, back to why we use active managers, the managers are assessing given the risks going forward: Am I going to be rewarded for that particular risk, given what’s actually occurred in the past?
So we’ve seen this very aggressive drive for yield. Maybe those companies that we hold today aren’t appropriate to hold for tomorrow, to grow those dividends going forward. So that can actually influence the outcomes in terms of what our active managers do.
Whitney Fitzsimmons: Peter before we go. What’s your outlook for the economy,
and where do you think the market will be by year’s end?
Peter Sumner: I think the market is more likelysimply to deliver the dividend return. Company earnings expectations are quite low, sort of in the nought to five per cent range. The Federal Budget, although positive, really sort of didn’t give a lot of scope to growth, or add to growth. And so essentially, a lot of companies are going to have to do some self-help. So in the medium term, I would expect that to be a pretty modest sort of return over the near-term.
Whitney Fitzsimmons: Peter Sumner, thank you for the update from the MLC Income Builder Fund.
Peter Sumner: Thanks very much for having me.