Selecting stocks based on high yields rather than the share market index will provide higher ongoing income post retirement, according to Merlon Capital Partners analyst Hamish Carlisle and chief executive Neil Margolis.
Carlisle said most investment companies chose assets based on the index weight, but selecting the cheapest stocks as measured by sustainable dividend yield across the market can allow fund managers to provide better outcomes for retirees.
He said that while traditional investment strategies may deal with the income and risk objectives of retirees, bonds and other forms of fixed income did not provide ongoing capital accumulation and therefore fell victim to inflation.
Carlisle said traditional strategies were skewed about 70 per cent toward growth assets, with the majority invested in shares and around one third tied to fixed income investments. Merlon’s post-retirement portfolio holds approximately 40 per cent in hedged shares.
Margolis said that because the index is skewed towards the big banks and mining, stock selection based on index weight does not diversify a portfolio enough to effectively manage risk.
"The problem with that of course is you carry a lot of exposure to one sector, which is not necessarily something that you want from a risk perspective; and you carry a large equity market risk skew as well, which again may not be what people are trying to achieve," Carlisle said.
He said the skew towards resources and banks is the "single biggest risk" in most post-retiree Australian portfolios, as traditional strategies place one third of shares in one sector which was a "substantial bet on China and…a very risky position to carry".
Carlisle said that using options, fund managers could avoid the typical trade-off between risk and yields. He said Merlon engaged in "value investing" by selecting the top 30 stocks as measured by sustainable dividend yield.
Taking into account franking credits, Merlon has provided 3 per cent higher returns compared to traditional asset allocation strategies by "titling towards yield in the portfolio, putting in place some protection using options and increasing…equity exposure", according to Carlisle.
